Can Things Only Get Better (Again)?
The July 4 General Elections in the UK resulted in a marked shift in government with the Labour Party winning a significant majority. In light of Labour’s manifesto and views on fiscal policy, we look at the possible implications for pension schemes and financial markets in general.
Stage Is Set
A new UK government will bring with it renewed scrutiny and focus on fiscal policy. So what does this look like for the Labour Party?
Fiscal rules were first adopted by Tony Blair’s Labour Party government in 1997 to demonstrate its commitment to sound public finances, and this is a strong theme in the Labour Party’s manifesto. Labour have committed to following two fiscal rules: the Borrowing Rule and the Debt Rule.
Borrowing Rule : Current budget (excluding investment spending) must move into balance, so that day-to-day costs are met by revenues.
Debt Rule : Debt must be falling as a share of gross domestic product (GDP) by the fifth year of the forecast.
Within the current framework and its fiscal constraints, there is limited scope for the Labour Party to ease fiscal policy to generate a long-term economic boost. While there is some headroom under the Borrowing Rule, the Office of Budget Responsibility’s (OBR) March 2024 forecasts showed that the Debt Rule was more binding and was only narrowly met under current policy.
The Labour Party have also committed to instituting the new Fiscal Lock. Under the Fiscal Lock protocol, it proposes to guarantee in law that any significant spending and tax changes that a government proposes are subject to an independent forecast from the Office for Budget Responsibility. This would avoid a repeat of the ill-fated “mini budget” market turbulence that was particularly prevalent in the Liability-Driven Investment (LDI) market under the Liz Truss government, which was not subject to OBR oversight. Going a step further, it has also committed to one major fiscal event a year, which will give more warning to markets of any fiscal changes that the party proposes.
While these actions are welcomed and should reassure investors, we note that, since 1997, there have been nine sets of fiscal rules, with the UK changing its targets more frequently than any other OECD country. Given the longer-term pressure on government finances, the risk of fiscal slippage remains high.
Labour have placed boosting growth at the centre of its agenda. Given the limited scope to use fiscal policy, it will instead need to rely on structural reform. Measures aimed at reforming the UK’s rigid planning rules and boosting the UK’s poor productivity levels could boost the UK’s potential growth rate.
In addition, the incoming government’s intent on improving relations with the EU may help boost international trade. Although Labour have ruled out rejoining the EU Single Market and Customs Union, its focus is on closer and meaningful ties with the EU and improving the elements of the trade deal by reducing trade barriers, alongside signing an EU–UK security agreement.
According to the expected foreign secretary David Lammy, the cornerstone of the relationship that the UK has with the EU should be one that drives closer liaison across economic, climate, health, military, cyber, energy and security issues that are harmonious for both parties, with a strong obligation to NATO.
What About the Pensions Landscape?
According to the manifesto, the Labour Party will ‘review the pensions landscape to consider what further steps are needed to improve pension outcomes and increase investment in the UK market’.
The commitment to boosting the UK economy by incentivising pension schemes to invest in UK productive assets is an important piece of their pension review. However, there is still no clarity on how these reforms will be implemented, as well balancing factors such as risk, return and stability for pensioners.
The reforms will also encourage workplace pension schemes to take advantage of consolidation and scale. Bringing focus to consolidating pension schemes should subsequently improve member outcomes through economies of scale. The detail in how Labour will carry out these reforms is one to watch. In addition, the Labour Party have committed to retaining the state pension triple lock system, ensuring continuity for current pensioners.
What About GBP?
From a currency perspective, we have seen sterling price in the benefits of a stable Labour government, with a more coherent tax policy and potential reduction of frictions with EU. The ongoing market reaction to new elections in France has provided further relative support to sterling. While we expect an initial positive reaction to the Labour victory, over the medium term, risks for the GBP are tilted modestly lower as the Bank of England starts its rate-cutting cycle to address the weakening labour market. Longer-term prospects for the GBP will hinge on the new government’s success in improving the UK’s anaemic economic growth and productivity.
Overall View
While we can expect potential positive measures for the UK economy from the new government, details up and until now have been vague and implementation risk remains high. We do not expect significant volatility or a knee-jerk reaction in the gilt market on the back of the change in government, and all eyes would likely be focused on the central bank and the first expected rate cut this year and any potential downward rate movement across the curve. Investors are likely to wait and see what the first few months of a Labour government may bring, before more fully reassessing the UK’s growth prospects going forward.