An election that matters
Only one question matters ahead of the 12 December UK general election: Will Boris Johnson and his Conservative Party win a majority of seats? Doing so would set the stage for an orderly Brexit, some pro-growth reforms and a sizeable fiscal stimulus that could lift real GDP growth above trend for a while. This remains our base case. If, however, the Conservatives fall short, uncertainty would rise sharply. Even if the Conservatives still won the most seats, they would have no obvious coalition partner to ally with. Labour would thus likely get the chance to form a government. While a Labour-led government would probably call a second EU referendum that may reverse Brexit, the UK would face fresh economic risks with the party’s leader Jeremy Corbyn – and his far-left policy agenda - as prime minister.
It is hard to imagine a more extreme choice for voters in a developed economy at the ballot box. Just a few years ago, it seemed unthinkable that the UK would find itself in such a situation. This should serve as a warning to other countries about what can happen when populism gets out of hand.
With 18 days to go until election day, two recent changes affect the outlook:
1) The polls have shifted further in favour of Johnson
Prime Minister Boris Johnson and his Conservative Party have edged further ahead in the polls. Latest opinion polls put support for the Conservatives at around 43%, up from c35% one month ago. The rise extends the Conservatives poll lead over Labour from c11pts to c14pts over the same period – Chart 1. We calculate that, as long as support for Conservatives remains close to or above 40%, a poll lead of at least 8pts over Labour keeps Johnson in the safe zone for a majority of seats.
In addition to the already announced rise in real current government spending and plans for a big step up in public investment, Johnson has unveiled two new fiscal policy changes during the past week. First, he wants to scrap the previous Conservative administration’s plans to reduce corporation tax to 17%, from 19% currently. This not a game-changer, in our view. Since 2010, the Conservatives have reduced the corporation tax rate from 28% already. The UK corporate tax rate is now the lowest among major advanced countries – Chart 2. Second, as expected, Johnson has announced that the Conservatives would aim to raise the threshold at which workers pay National Insurance to £12,500 over the course of next parliament, from £8,628 currently. In 2019 money, an increase in the threshold to £12,500 would represent a rise in take-home pay for the median worker of c2% - Chart 3. The Conservative Party manifesto includes a promise to raise the threshold to £9,500 in 2020. While, on its own, such a modest increase in the threshold would only boost consumption at the margin, a gradual rise in the threshold over time could provide steady support to real take home pay growth and lift medium-term consumption growth.
As our base case we look for real GDP growth to accelerate from 1.3% this year, to 1.8% in 2020 and 2.1% in 2021.
2) Labour’s economic policies pledges are more dangerous than anticipated
The Labour Party’s election manifesto sets out plans for widespread nationalisation, increased regulation and a much larger state financed by a significant rise in taxes, plus extra borrowing to finance a rise in public sector investment from £47bn in 2019/20 to £114bn by 2023/24. Labour wants to nationalise broadband, rail, postal services, water, energy and all private sector contracts with government. The party’s pledges to increase current annual government spending by c£80bn by 2023/24. Labour wants to finance this by increased taxes on incomes at the top end, on corporations (especially oil-producers) and on capital gains while introducing new taxes on financial transactions tax.
The plans marks a further significant shift left relative to Labour’s 2017 election manifesto which was already decidedly left wing by UK standards. The new plans promise an extra £30bn increase in current spending versus two years ago. A Labour-led government would transform the UK from a mixed economy with a clear tilt towards free markets, supported by a light-touch approach to regulation and a relatively small government sector, to a mixed economy with a clear tilt towards public ownership and production and more centralised control of economic activity. The plans represent a serious downside risk to UK growth potential that would likely exceed the hit from Brexit.
While a Labour government remains unlikely, it is the key tail-risk to watch. Based on current polling, it seems inconceivable that Labour could win a majority outright. Chances are that, even if Johnson fails to win a majority, Labour would be short of a majority too and thus would need to find a coalition partner in order to form a government. The pro-market, mostly fiscally-prudent, Liberal Democrats have hinted that they would rather go for repeat elections than join forces with Labour under Corbyn. A more realistic coalition partner for Labour would be the SNP (Scottish National Party) – but that could only happen if Labour promised to give the SNP a second Scottish referendum. Whether the SNP, whose main ambition would be to get a second Scottish vote, would temper Labour’s policy agenda is unknown.
Despite some chance that the UK could remain in the EU under a Labour government, on balance, the economic risks from Labour’s economic plans and the increased political uncertainty stemming from a second referendum on the EU and on Scottish independence would tilt the economic risks from such an election outcome strongly to the downside.
Some feedback from the US – mostly constructive
Along with Berenberg’s chief economist, Holger Schmieding, I spent the last week in meetings in the USA discussing these and other key issues with market participants. On the whole the mood was constructive. Most agreed that a) the hard Brexit risk has receded materially since Johnson managed to strike a new Brexit deal with the EU some five weeks ago, and that b) a Conservative majority on 12 December would be positive for UK risk assets while a Labour victory would be a negative surprise for markets – despite the chance of reversing Brexit. But given that some of the good news has been priced in already, highlighted by the appreciation of trade-weighted sterling, few investors seemed ready to further increase their exposure to the UK ahead of the election. This, in our view, sets the stage for a further rally in UK-focused stocks – and sterling - if Johnson wins. While some investors remained concerned about the prospect of a potential hard Brexit at the end of 2020 when the Brexit transitional period is scheduled to end, the election and its implications remained the most pertinent issue at hand for now.
Kallum Pickering
Senior Economist
Phone +44 203 465 2672
Mobile +44 791 710 6575
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