So far, the pound has been one of the winners of the General Election. Cable has generally been higher over the course of the campaign, as polls showed who would win by a wide margin. And, unlike in France, the polls ended up being largely accurate, reassuring investors about their predictions.
The new Labour government has taken pains to continue to reassure markets that there won’t be any major changes to fiscal policy. No one wants a repeat of the disaster that was Liz Truss’ “mini-budget”, and there was a possibility of a similar situation based on historic precedent.
Why Labour Won’t Spend (For Now)
We should recall why the “mini-budget” was such a fiasco: The core problem is that the new Chancellor at the time, Kwasi Kwarteng, announced a series of tax reductions, something that the Conservative base would really like. But, without that revenue for the state and not clearly articulating how spending would be cut at a similar amount, that meant the debt would increase.
With a debt-to-GDP ratio of 97.6%, the UK is essentially “tapped out”, and further debt increases would raise questions about how it would be paid. In order to compensate for that, interest rates would rise, jeopardizing the BOE’s policy and potentially putting financial institutions in receivership. Since then, the debt situation has actually gotten worse, meaning that any hint at debt increases would bring back the specter of the mini-budget.
Meet the New Boss, Same as Old Boss
Increasing spending without also increasing taxes would have the same basic effect as what the “mini-budget” did. And raising taxes significantly in the current environment would hurt the very tepid economic rebound. So, Labour is essentially tied to the same amount of income and spending capacity as the prior government, keeping the fiscal status quo in place.
The new Chancellor, Rachel Reeves, has gone to great pains to reassure markets of this situation, which is why the pound remains relatively stable. The main difference is that where Jeremy Hunt was looking for every opportunity to cut spending in order to cut taxes, Reeves will likely look for every opportunity to increase spending while maintaining the current taxes.
How It Affects the Markets
The overall effect is likely to be slightly inflationary, which is what the market seems to be pricing in. That is, before the General Election, the expectation was that there was around a 60% chance of a rate cut in August. After the General Election, it’s about the same. But Gilts are slightly higher reflecting an expectation that the rate cutting path for the BOE will likely be longer. That is, it will still cut the same amount, but will take longer to get around to it.
Markets were widely anticipating this, which explains the run-up of cable before the election. Now the attention turns to economic indicators, with GDP growth seeing as giving the BOE more discretion to hold rates higher. That would be beneficial for the pound.
The consensus is that May monthly GDP improved by 0.1%, compared to 0.0% prior. But that would maintain the average 0.7% growth for the rolling three months, a sign that the economy continues its rebound from last year’s technical recession.
