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UK strategy update – a Conservative majority

13 May 2015 Tristan Hanson, Ashburton Investments
Tristan Hanson, Head of Asset Allocation at Ashburton Investments.

Tristan Hanson, Head of Asset Allocation at Ashburton Investments.

It was a result which surprised almost everyone. David Cameron’s Conservative Party swept to victory in last Thursday’s general election, sealing a small outright majority which very few thought possible beforehand. Speculation around possible coalition permutations involving either of the leading parties were put to rest. The poor showing by Labour and the Liberal Democrats prompted the swift resignation of their respective leaders, Ed Miliband and Nick Clegg. The other big news of the night was the tidal wave of support for the Scottish National Party, which managed to secure 56 of the 59 Scottish seats, decimating previous Labour territory north of the border.

Market reaction

The immediate market reaction has been a strong rally in both the British pound and the UK stock market. A Conservative majority government removes the uncertainty and potential instability that messy coalition politics might have brought; while it was also a victory for the more business friendly party.

In contrast to a potential Labour-led government promisingprice and rent controls, higher taxes and the introduction of a ‘mansion tax’, the Conservative victory has sent the share prices of property-related companies, utilities and financials sharply higher in a generally buoyant stock market. The FTSE 100 closed up 2.3% on Friday at 7,047.

Two major medium-term issues

The election result throws up two major uncertainties which are likely to manifest themselves over the medium-term. One is Britain’s place in Europe; the other is the makeup of the United Kingdom itself, given the surge in support for the Scottish National Party (SNP).

The Conservative victory makes it a certainty that the UK will hold a referendum on EU membership by 2017. The risk that the UK might leave the EU may create uncertainty for businesses considering whether to invest in the UK. The strength of the SNP means further powers will be devolved to Scotland at the very least, but also opens up the possibility ofanother referendum on Scottish independence and potential break-up of the union.

It is probable that neither of these two risks manifest themselves immediately. A referendum on Europe may be two years away, while the majority of the population appear to support ongoing membership of the EU, for now at least, anyway. Cameron’s negotiating power with the EU and his own party is strengthened by this showing, although Tory euro-sceptics will inevitably make their voices heard. Another Scottish referendum would likely come even later.

Whither sterling, gilts and the FTSE?

The election result is unlikely to have any significant bearing on the near-term outlook for the UK economy and a continuation of recent steady growth seems most likely. The new Conservative government is likely to continue emphasising deficit reduction, which means tight fiscal policy will remain a headwind to economic growth. Pro-austerity government policy should be positive for gilts, other things equal, and we expect UK yields to trade below US yields, as they have for the past six months.

Sterling has strengthened in response to the news. We agree that the decisive result has reduced the uncertainty that another hung parliament might have brought and therefore, given the result, it is not surprising that sterling has rallied in the short term. However, there is likely to be a feedback loop between the currency and Bank of England policy – significant currency strength is likely to dampen the central bank’s appetite to raise interest rates, absent any accelerationin growth.

The sterling/euro exchange rate is most important in this regard since Europe remains the UK’s largest trading partner. We expect the euro to continue its depreciation against the US dollar after the current bounce and think this will also exert a downward force on sterling against the dollar. Potential referenda on EU membership and Scottish independence present additional downside risks to sterling, although as stated above, we do not believe these present any imminent concern. Overall, the US dollar remains our preferred currency major.

Consistent with our views on global equities, we expect UK equities to continue to trend upwards and outperform cash and gilts. The market has already rewarded sectors expected to benefit the most from Conservative policies, while many large-cap UK equities that dominate the FTSE 100 are global in nature and rely less on developments within the UK.

Conclusion

The 2015 UK general election will be remembered as a dramatic political event for many reasons – a brutal night forLabour and the Liberal Democrats, the dominance of the SNP in Scotland, the false predictions of the pollsters and the first Conservative majority election victory since 1992. From an economic point of view, a Conservative victory broadly signals a continuation of policies from recent years.

As ever in a globalised market, what happens to UK asset prices or the currency will also depend not just on local developments but also on what happens in the rest of the world. Central bank policies across the major currency blocs will continue to have a large bearing on asset prices, both at home and abroad.

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