Labour victory – What can the UK economy and markets expect?

For Professional, Accredited and Institutional Investors only.

Oisin O’Leary – New Capital Dynamic UK Equity Fund Manager

Labour will be inheriting one of the weakest government positions from a financial perspective in decades – high debt, high tax burden, limited fiscal headroom, and low growth. On top of this there is the world’s deglobalisation trend, the green transition, and increasing protectionism to contend with. Labour has moved notably more centrist in its standing under Starmer, who has spent the last few months purging the party of its more radical left members. New chancellor Rachael Reeves is likely to be one of the most orthodox chancellors that the UK has had for a very long time, with an economics plan that does not require a complete change of direction. Reeves’ ‘Securonomics’ vision is to prepare the economy for the geopolitical and technological shifts that are underway using the government balance sheet to stimulate the clean energy transition, boost infrastructure, encourage investment in new technology, and build resilience into supply chains in the UK economy. At the same time, she has broadly committed to the previous government’s fiscal rules and believes in the checks and balances of the financial system, leaving very limited fiscal spending headroom to fund these plans.

Labour Victory's Limited Market Impact, Key Sectors to Watch

From an equity market perspective, a labour victory has been expected for some time and we expect this to have been largely priced in prior to the day of the vote. Also, given the large degree of crossover in party manifestos and the limited fiscal headroom constraining any major policy shifts, it is not expected that there will be much change to the status quo for the majority of UK corporates in the near term. There are, however, some sectors/themes that we expect could see some changes under the new government.

Most prominent would be UK housebuilders. Labour has clearly identified a reform of the planning system as a path to spurring an infrastructure and housing construction boom to boost growth, a vision that the Tory government attempted to deliver but was ultimately unable to. Labour is likely to be focused on affordable housing, and so we would expect those housebuilders exposed to the lower end of the property market to be the biggest beneficiaries – all this said, however, we expect that the path of interest rates will be a larger determinant of share price direction than political factors over the near term. Anecdotally, we have also spoken to several companies in the industrials and staples sectors in recent months who have expressed hope that planning reforms will help accelerate greenfield expansion projects (new warehouses, factories etc.) that have been held up by the current system, and this would unlock new growth potential in these businesses.

Another potentially interesting sector to consider would be utilities, though some nuance is needed here. While the Conservative government both relaxed climate policies and delayed ESG regulation more recently, Labour has placed the UK’s Net Zero ambitions at the core of its ‘Securonomics’ plans and aims to decarbonise the power grid by 2030. Establishment of the £8bn Great British Energy Plan and £7bn National Wealth Fund, as well as streamlining project deployment processes should be supportive for electricity networks and power generation, as well as renewables. On the other hand, there has been a considerable degree of discourse from Labour around the water sector given recent controversies around environmental standards & sewage spillages, and we would be wary about both political and regulatory headwinds water providers could face going forwards.

Labour has also stated that they will increase and extend the Energy Profits Levy, and potentially reduce some of the investment-related offsets that had been in place under the Conservative government. While on a headline basis this would be negative for the Oil & Gas sector, we believe the financial impact for the UK listed majors to be relatively muted, given their limited exposure to the UK from a profits perspective. In our view, smaller independent E&Ps (exploration & production) with a greater exposure to UK North Sea will likely be negatively impacted, however.

The banking sector is another important part of the UK economy to consider, but here status quo appears to be the outcome on the surface, with Labour vocal in their intention to not increase taxes beyond what has been already announced. What hasn’t explicitly been ruled out, however, is the idea of changing the rate of interest the Bank of England pays on reserves which could act as a stealth tax to the UK banks and would be a clear negative for the sector. Such a change, which would replicate moves in Switzerland and Europe, could hypothetically raise billions of pounds. This would be tempting for a government facing incredibly tight budget constraints and is therefore a possibility that should not be ruled out.

Beyond these sectors the impact of a Labour government appears relatively limited in scope, with most companies that we have spoken to expecting no changes to the status-quo. What is likely to have a much more material impact across a broader range of UK companies and sectors will be the path of interest rates. With political noise now fading into the background somewhat, the focus can now turn to the Monetary Policy Committee meeting on August 1st, where the market currently expects the first rate cut to be announced.

UK Stock Market Reform: Labour's Plan to Boost Domestic Investments

Beyond sectors and companies, there have also been positive signs on the political front relating to much needed UK stock market reform. For many years the UK has been ‘cheap’ – trading at ever widening valuation multiple discounts both to its own long-run historical averages as well as relative to other major equity markets – as net flows into UK equities have been stuck in negative territory. The key question is what will be the catalyst for change? A positive first step was the announcement of the British ISA in the September budget, but a more important catalyst, in our view, is the commitment in the Labour Party Manifesto to increase investment by UK pension funds in the domestic stock market. UK pension funds are an outlier on the global stage for the percentage of investments they hold in their home market, with the 2023 Capital Market Industry Taskforce (CMIT) report highlighting that UK pension investment in UK equities had collapsed by 89% over the last 25 years, representing a withdrawal of £1.9trn from UK equities. If Labour is successful in reversing this capital flow dynamic through political intervention, perhaps the long running UK equity market discount could be reversed.

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