What’s next for Sterling post-election?

As the results of the UK general election filtered through during the early hours, markets responded with a shrug to the anticipated Labour majority victory under newly-appointed Prime Minister Keir Starmer. Despite a narrower victory margin than both the polls and models had predicted, the impact on sterling has thus far been muted, reflecting investor preparedness for the political landscape that lies ahead.

Stable Sterling Amid Political Certainty

There was no real reaction in sterling during Asian trading overnight, as both the exit polls and official results merely provided confirmation of something that markets had long been pricing in: a comfortable Labour majority. With a handful of constituencies still to declare at the time of writing, the margin of victory will actually end up being quite a lot less than both the polls and projections had anticipated - Electoral Calculus was pointing to a near 300-seat drop for the Tories and a huge Labour majority of around 280 seats. This will, however, do little to impede new PM Starmer’s ability to force policy changes through the House of Commons, as Labour easily obtained the 326 seats needed to form a majority government.

Potential Upswing for UK Assets

Financial markets have viewed a Labour government as the best-case scenario for both the UK economy and the pound leading up to the election - GBP has been one of the best performers in the G10 this year. We have viewed this as a consequence of the below:

1. The likelihood of closer UK-EU ties under a Labour government.
2. A clear shift towards the political centre within the Labour Party since 2019.
3. The modest tax hikes proposed in the Labour manifesto.
4. Lingering damage done by a perceived mishandling of the UK’s finances by the Conservatives.

We think that UK assets could remain well bid in the coming weeks, should the removal of the admittedly mild political uncertainty lead to an improvement in business and consumer confidence. We could also see additional upside should Labour ramp up their rhetoric in favour for closer UK-EU relations, which has arguably provided the main source of optimism for market participants in the lead-up to the election.

The Fiscal Challenge Ahead for Starmer

Perhaps the biggest challenge for Starmer will be convincing investors that he has a credible fiscal plan that will boost UK growth. We suspect that Labour will initially adopt a cautious approach to both taxes and spending, for risk of triggering an adverse reaction in bond markets. Indeed, both the tax and spending increases outlined in the Labour manifesto were only relatively modest (0.35% and 0.2% of GDP respectively). While this is partly a reflection of the limited room for fiscal manoeuvre, it also provides a clear indication of the shift to the political centre within the Labour Party since 2019, which now much more closely resembles the status quo than under Jeremy Corbyn’s leadership.

In the longer-term, markets will be watching closely to see whether another prolonged period of sluggish UK growth triggers Labour to backtrack on any of the fiscal plans laid out in the party’s manifesto. Any suggestion of larger tax hikes than those so far outlined would no doubt be greeted unfavourably by market participants.