Many investors are worried that the United Kingdom’s stellar economic run over the last few years may be coming to an end—last week’s GDP reading was the weakest since 2012—and that one of the strongest performing economies in Europe could possibly start to head the other way post elections this week.
It’s impossible to tell what the outcome of Thursday’s election will be, since last week’s polls showed the Labour and Conservative parties neck-to-neck for the lead. Both have their drawbacks, a Conservative party victory increasing the likelihood of an exit from the European Union—although the latest polls indicate Britons believe there is some economic benefit to being a part of the EU—while most expect a Labour victory to lead to greater public spending and a negative time for business.
Many investors are also concerned about the power of the anti-austerity Scottish National Party, which polls show is on track to win a landslide majority and has indicated its willingness to support the Labour party but not the Conservative Party. Either way, investors such as Matthew Beesley, portfolio manager of the Henderson International Select Equity Fund, are bracing for a “new paradigm” in U.K. government. For him, neither a Tory nor a Labour-led coalition government bodes well for the markets, because neither would be able to put together a meaningful coalition capable of addressing some of the inherent problems in the U.K economy.
“As a bottom-up investor, I have already met some multinational companies that say they’re not going to invest in the U.K. for fear of it leaving the EU in 2017 and all that that implies,” Beesley said. “The election outcomes are going to lead to a period of uncertainty at the margins.”
While the rest of the Eurozone struggled to get back on its feet and experienced negative growth, the U.K. economy grew rapidly. Today, unemployment in the U.K. is half that of the Eurozone and living standards in the U.K. are also better than elsewhere in Europe, largely because of the U.K. government’s pro-active approach in dealing with the fallout from the financial crisis, said Stuart Quint, senior investment manager and investment strategist at Brinker Capital.
Those gains could reverse, though, after the election, particularly if the Labour Party wins and is in the car seat to drive a coalition, “you will definitely see volatility in UK assets,” Quint said “The pound may also strength slightly to the extent that you’ll have a Bank of England that is more hawkish. It’s clear that equities and bonds will be more favorably disposed toward a Tory victory.”
Labour Party lead Ed Miliband has also “alienated” company CEOs, Quint says, “and many companies are wondering why invest in the U.K.”
The impact of that is starting to be felt in the U.K., which has also been struggling with a slowdown in productivity growth, Beesley said. “We haven’t really seen wages rise and though we may have done better than other economies, and the weak sterling has helped a lot, there are weaknesses in the economy that this election will definitely expose.”
For many investors, the ideal election outcome for the U.K. economy would be a government that continues to be led by Conservatives and Liberal Democrats. Over the past five years, their coalition government has successfully reduced the budget deficit through an austerity program. However, the budget deficit was 5.7% of GDP last year, which is very high, and the U.K. is also running a large current account deficit.
Like other economies in Europe, the U.K.’s also depends on its exports, said Quincy Krosby, market strategist at Prudential Financial.
“You need a strong global underpinning for exports to do well, so even at the margins, if you see pickup in demand from the U.K.’s major partners, which includes the U.S., China, Japan, and their natural partners in the EU, that will help the U.K. economy overall.”
Most importantly, though, the U.K. needs the kind of strong government that can deal with growing problems in the right way, so that the risk of losing the gains of the past few years are not too easily lost.