General Election 2015 – the story so far

Officially the UK general election campaign is about halfway done, unofficially of course it is ion the final stages of a marathon that kicked off with the 2014 March budget and its new pension freedoms. There are some signs that the electorate have “hit the wall” with regard to tolerance for political points-scoring.

For the last twelve months the poll ratings for both Conservatives and Labour have remained roughly equal at 30-35% apiece. UKIP consistently poll in third place but their support appears to have peaked at the European elections last May and since then have drifted back from the high teens to the low teens, the Lib Dems and the Greens split a further 15%. The most important change barely registers in the national opinion polls but the SNP has seen a strong surge in support throughout Scotland following the defeat of the referendum vote on independence.

In terms of parliamentary seats, the peculiarities of the constituency-based, ”first-past-the-post” system are making their mark. According to electionforecast.co.uk the SNP with about 4% of the overall UK vote will win 47 seats whilst the Lib Dems with about 7% of the vote look set for 24 seats, while UKIP with about 14% will win only 1 seat, and the Greens who generally poll above the Lib Dems will hold onto their 1 seat. The Conservatives look set to win more seats than Labour (283 to 271) with a similar share of the votes, due to Labour’s losses to the SNP..

This looks likely to leave the country in a position where not only will no single party win enough seats for a majority, but quite conceivably the only coalition outcomes that would secure a majority will be Conservative / Labour or Conservative / SNP. Neither of these seem remotely likely to occur. The most likely outcome now is in fact not a coalition, but a minority government supported by other parties on an issue-by-issue basis.

The parliamentary arithmetic will be keenly balanced between those smaller parties willing to support a Conservative minority government in a vote of confidence, and those willing to support a Labour minority government. Miliband may well be likely to win fewer seats than the Conservatives but be more able to win a vote of confidence within parliament.

For some time now the Conservatives have been expecting to pull ahead of Labour in the polls as the economic recovery has taken hold, but this has failed to occur. There is a belief in Conservative circles that the last few days of the campaign will see a surge in support for them, when voters finally decide who to vote for. Indeed polls show that a large number of investors have not yet definitively decided how to vote. It seems though that the image of the Conservatives as the “nasty party” as Theresa May famously remarked, has not disappeared from many voters’ minds, despite good economic news.

As in the 2010 campaign, no party is prepared to give details of precisely where the future austerity which their economic policies require will actually hit – it seems they fear the truth on this is too painful for the electorate to bear.

More remarkable is the recent narrowing of policy differences between the two major parties. Having trumpeted the positive effects of sticking to their “long term economic plan” for so long, in the campaign Cameron has been very quick to make new campaign pledges for more money for the NHS, subsidies for commuter rail fares and reductions in Inheritance Tax. None of these previously appeared in the long term plan or appear to have been funded by savings elsewhere. Similarly Labour, having criticised the policies of austerity over the last five years, has placed bearing down on the deficit at the heart of its manifesto, and has resolutely refused to embrace any unfunded campaign pledges in order to demonstrate its fiscal responsibility. Both parties are seeking to win over the centre ground of voters – the Conservatives by showing by spending more and Labour by spending less!

Perhaps the most important statistic in this campaign is that more than 60% of the electorate (and an even higher proportion of those who will actually vote) are over 55 years old. For most of these voters it is pensions, be they provided by the state or by private provision, which are their critical focus. This is now probably a more important issue than jobs for this age group and is perhaps a factor in why the rising number of jobs is not feeding through into Conservative voters.

With two weeks to go, this election remains too close to call. The UK financial markets have been happy to ignore the political uncertainty to date – a minority government of any sort may be seen as a negative development by the currency and gilt markets on the basis that it will be difficult for the government to implement its policies. On the other hand a weaker sterling is usually good news for UK stocks and politicians who are unable to do anything could be seen as good news in that they are unable to mess anything up!

Drifting towards constitutional chaos

Typically markets give little consideration to political events until they are right on top of them, so it may now be appropriate to give some thought to the possible outcomes of the UK general election. Nationally the poll ratings for Conservative and Labour have been very steady for well over a year now, though ibn Scotland Labour have been losing significant numbers of voters to the SNP. A parliament of 650 MPs made up of approximately 280 Conservative, 270 Labour, 30 Lib Dem, 50 SNP and 20 other (15 Unionist and UKIP on the right, 5 Green and Plaid Cymru on the left) is close to that implied by the political betting markets and current polls, and would leave the UK political scene in a very uncertain state.

This would leave the traditional right-of-centre parties at 295, the Labour, nationalist and Green parties at 325 and the Lib Dems in the centre with 30. The implication would be that the only two-party coalition majority that could get close to a majority would be a Labour/SNP coalition; however the price of such a coalition would very likely be the break-up of the UK itself. Alex Salmond would be the SNP leader in Westminster and he has shown himself to be a very effective political operator in the coalition politics of Holyrood.

Sadly no other outcome looks good for markets either:

  • Traditionally the best outcome for markets would be a majority for a stable right-of-centre government. A Conservative majority, while looking extremely unlikely at the current juncture would however be one fraught with political and constitutional risk as the Conservative manifesto will commit to holding a referendum in the UK’s continued membership of the EU. The uncertainty that such a referendum would engender in the minds of business leaders would be very negative for investment in the UK, and a vote to withdraw is likely to be viewed very negatively by the UK financial markets.
  • A continuation of the present Conservative/Lib Dem coalition, is also not likely on the current poll ratings. It would however be likely to feed continued Scottish disgruntlement, where neither of the UK governing parties is likely to have much representation north of the border. Further demands for more powers for the Scottish parliament are also likely to be met with stronger rhetoric for English-only MPs deciding English matters, bringing the very concept of the Union under deeper strain.
  • A minority Conservative government would find it very difficult to get its economic and budget policies through parliament, where a combination of Labour, Lib-Dem and SNP votes would block most of their plans.
  • A Labour/Lib Dem coalition looks unlikely to have enough support within parliament by itself, it would be dependent upon support from the SNP to pass legislation and that support would come at a price. The same would be true for a minority Labour government.
  • A Labour majority would not be welcomed by financial markets as Ed Miliband is perceived as one of the most anti-business Labour leaders since Michael Foot.

Weak government and constitutional uncertainty look to be the only sure thing to come out of the forthcoming election. Weakness in the euro is the current flavour of the month in the currency markets, following the ECB’s decision to (finally) implement QE. By the time May is here, it may be they are seeking a new trend – weak sterling on the back of political uncertainty could well be that new trend.

2015 – a double election year?

2015 looks set to be a particularly political year, with the possibility of there being two general elections looking increasingly plausible. In the last six months, the strong performance of UKIP in the European elections and the SNP in the referendum vote, have seen UK politics move from the three party affair thrown up by the 2010 election (itself a radical departure from the two party politics naturally favoured by a first-past-the post system) to one where the fortunes of five different parties need to be considered to determine the final outcome of the 2015 election. One could add the Green party as a sixth, given their existing one seat and recent improvement in the polls.

In a constituency system with just one vote, a candidate merely needs more votes than any other candidate, and does not need the support anything close to half the electorate to win. In a 4-way competition, just 25.1% could theoretically be sufficient to win the seat. Thus the impact of new parties drawing votes from existing parties can make predicting the winner of any individual constituency incredibly difficult.

UKIP are currently showing at 17% in the opinion polls, with their support being drawn approximately ¾ from former Conservative voters and ¼ from former Labour voters. This could be enough to win a handful of seats, but the more important national impact could be the split in the Conservative vote allowing Labour to win some individual constituencies where they would not otherwise expect to have sufficient support.

The interest and passion displayed by the Scottish electorate in the independence referendum has continued since then and the SNP has in recent polls been drawing huge support from former Labour voters in Scotland, where Labour currently holds 41 seats, which are now under threat.

Support for the Liberal Democrats collapsed from the 26% achieved in 2010, from the moment they reversed stance on student fees in the initial Coalition Agreement. Their 7% showing currently in the opinion polls is very poor but their MPs tend to have built large local support bases in their constituencies and they are likely to win more seats than their national support would suggest.

The two major parties have not between them garnered the support of more than 2/3 of the electorate since the last election campaign (in 1945 they took 95% of the vote, but have been in decline since then). The current distribution of constituencies favours Labour, who hold many inner city constituencies where the size of the electorate has shrunk over the years, whereas Conservative constituencies are more concentrated in the suburbs where electorates have been rising.  Until recently, most analysts believed that Labour could win a parliamentary majority with just 35% of the national vote, whereas the Conservatives needed to win about 40%.  The recent rise of UKIP and the SNP probably means that these estimates need to be increased.

On current YouGov forecasts, not only will neither Conservatives nor Labour win a majority of seats, a coalition of either party with the Liberal Democrats will also not produce a parliamentary majority. The most likely outcome of the May 2015 election is thus a second election in October/November next year.

Opinion polls do fluctuate and there are still almost six months until the poll that matters, but the electoral arithmetic against a stable outcome looks difficult to overcome. For UK financial markets this may be troublesome in 2015.  This was always likely to be the case as a Conservative-led government would be committed to holding a referendum on EU membership in 2017, which would generate huge uncertainty in the minds of business with regard to investment in the UK, whilst a Labour-led government would be led by Ed Miliband, who would be seen as the most left-wing and anti-business Prime Minister that the UK has seen.

It is difficult to work out what a good election outcome would be for the financial markets.

Gilts or Kilts

In recent weeks the gap in opinion polls between those in favour and those against Scottish independence has narrowed from about 10% to about 5%. With some months of campaigning still to go, the vote on 18 September looks increasingly likely to be close. What are the likely political, economic and market implications of a Yes vote?

Political implications

  • Negotiating the split. The SNP envisage 18 months of negotiations prior to becoming independent on 24 March 2016. However, they would be negotiating with the UK government and there is a general election due in May 2015 which could easily lead to a change in the governing party or coalition. The outgoing government is unlikely to deem the negotiations as an important priority, and the new government may well have more pressing policy priorities than reaching an agreement with Scotland – the power is biased towards the UK Government in the timing and pace of any negotiation.
  • Impact on Westminster parliament. Should a new government be led by Labour, then they face the risk that after March 2016, with an independent Scotland in place, the Scottish Labour MPs would have no right to vote at Westminster. This could easily deprive such a government of their majority and could lead to a general election or a change in the governing party. Such a scenario gives a very strong incentive for a Labour-led government not to reach an agreement with the SNP. A UK parliament with no Scottish members would mean a near permanent majority for the Conservative party and a clear rightward shift in the political debate in the rest of the UK.
  • EU membership. Under current EU law, Scotland would have no automatic right to become a member of the EU – in theory, it would have to negotiate terms and win a unanimous vote from all the other countries. This is by no means certain as Spain in particular is likely to vote against such a move, given its concern about setting any precedents when its own Catalan people are calling loudly for independence.
  • United Nations. If Scotland were to leave the UK, it would be likely to reduce the global political influence of the rest of the UK. Its permanent seat on the UN Security Council might well be called into question, as it would be the smallest country with that privilege. Even today, with Scotland, the UK is less than 1% of the world population.

Economic implications

  • Currency. All three major UK parties at Westminster have been clear that they would not agree to a currency union with Scotland. In practice, however, they could not stop Scotland from using the pound, though in that situation Scotland would have no influence over the UK’s monetary policy set by the Bank of England. In theory (again), if Scotland were to become a member of the EU then any new member of the EU has to adopt the Euro as its currency. Creating a brand new Scottish currency is also possible, but would create the need for foreign exchange transactions and heavy costs for Scottish businesses.

 

 

 

A negotiated agreement, which created a formal currency union, would allow Scotland to keep the pound and possibly have a Scottish member on the MPC. However, events in the Eurozone in recent years highlight the dangers and effective loss of sovereignty in being a small country in a currency union when there is no fiscal or political union.

  • Banking system. RBS is the largest Scottish bank with a balance sheet of over £ 1 trillion at the end of 2013 (and this has halved over the last 5 years) with capital of almost £60 billion; given the size of the Scottish economy, a Scottish government could not credibly act as backstop should RBS get into financial difficulties again, whereas currently RBS does benefit from being an institution of systemic importance in the UK that the government is committed to supporting in extremis. Scotland’s ratio of banking assets to GDP is 12:1, which is higher than the peak levels seen in Iceland in 2007. It is likely that RBS would choose to relocate its headquarters to London, which would lead to the loss of a significant number of jobs in Edinburgh.
  • Dividing assets and liabilities. Scotland is about 8.5% of the UK’s economy and population. The SNP is claiming just about all of the UK’s North Sea Oil, its major resource asset, since it would lie in Scottish territorial waters, but only expects to take on 8.5% of the National Debt. The UK government might argue that North Sea Oil belongs to the UK today and so be prepared only to cede 8.5% of the resource asset. The stream of revenue from taxation on North Sea Oil is a key source of money to pay for future welfare spending in Scotland, and the SNP’s economic forecasts assume much greater tax revenues in future years than the forecasts of the current UK government.
  • Credit rating. As a relatively small and new country, with a reasonably high initial level of debt, Scotland would be likely to have a lower credit rating than the rest of the UK, even if there were a strong currency union in place; this will increase borrowing costs for Scotland. There is an additional danger that by reducing the size of the UK economy, and with investors implicitly believing that in a crisis the UK would come to Scotland’s rescue, that the UK’s credit rating would in fact be lower as well. Both countries could lose out.
  • Tax revenues. A number of Scottish-headquartered companies have indicated that it may be commercially necessary or desirable to have a UK headquarters for their business outside Scotland, due to all the uncertainties regarding currency, trade, tax, EU membership and regulation. This might substantially reduce the corporate tax revenue to a new Scottish government from Scottish companies.
  • Prices. Many companies in the UK have national pricing policies, which effectively subsidise providing goods and services to less central regions such as Scotland. Tesco have already indicated that they might adopt a national Scottish pricing policy, which would mean higher prices for Scottish shoppers.

Market implications

  • Currency markets. Sterling is likely to be viewed as a less attractive currency, since it may be backed by a smaller country and tax base than it is currently, and would generally carry less weight or influence in wider world affairs. The most likely market response to a Yes vote in the referendum would be for Sterling to fall against the other major currencies, and gilt yields to rise.

 

 

 

  • Effect on business investment. For business, a vote for independence would undoubtedly create a whole range of issues, about which there would be uncertainty and risk. On pensions, for example, there are completely separate EU regulations for pension funds which cover more than one country.  This may require large extra contributions by companies to deal with current deficits.   In financial services, many providers may judge that it would be preferable to be regulated by the FCA alone rather than by both the FCA and a new Scottish regulator, paying extra regulatory fees. Firms carrying out regulated activities might seek to move employees outside Scotland. All such uncertainties would be likely to lead to delays in investment spending by businesses.
  • Scottish bonds. A new market in Scottish government debt would need to be created, and such debt would be likely to trade at higher yields than the debt of the UK. UK government debts are called gilts and any Scottish government debt has already being colloquially labelled as “kilts”.

The possibility that Scotland might vote NO, but with a very small majority should also be considered.This could be the worst possible outcome since the SNP would undoubtedly believe that a second referendum, in say two years, might enable them to get over the line. International investment into Scotland would be likely to be damaged as investors would have no clarity on Scotland’s legal status and the UK government might well believe that it would derive little benefit from supporting the Scottish economy by, for example, relocating civil servants there.

In the long term, both Scotland and the rest of the UK could be viable, solvent, independent but closely allied, political entities – if both existed today, there would be no obvious reason or need to suggest they form one larger country. However, the transition from the current version of the UK to a smaller version would create major political and economic uncertainties that would be likely negatively to affect business and the economy in the short term. The period of negotiations spanning a UK general election is particularly unhelpful in this regard, and the ramifications on Scotland’s relationship to the EU are significant, but extremely unclear.

It is striking that with less than five months until the referendum, how many major unanswered questions there are about what would happen in the event of a YES vote. In no particular order, these are (i) what currency would Scotland use and how much influence would Scotland have over its monetary policy? (ii) would a newly independent Scotland be a member of the EU and on what terms? and (iii) what happens if no satisfactory agreement can be reached in any negotiations between Scotland, the UK government and the EU? Clear answers to these questions would provide a much more satisfactory basis for Scottish voters to make an informed choice.

For now, assuming a NO vote with a reasonable majority, there are no investment implications. A narrow NO vote or a YES vote would be likely to be negative (but not hugely so) for the bond markets and for the currency, but the weaker currency would be likely to be a positive for the stock market. The impact on financial markets would depend on how constructive the UK government and the European Commission choose to be in dealing with the Scottish representatives seeking to create a new country.

Both Osborne and Cameron can count themselves a little unlucky- December 2011

As with football managers, the ability of politicians to keep their jobs can be defined by the formula – Success = Outcome minus Expectations.

A year ago, George Osborne set out his plans for getting the UK public finances onto a more secure footing. To counteract the Treasury’s longstanding record of over-optimism in forecasting trends in the UK economy, he set up the Office of Budget Responsibility, as an independent body to give greater credibility to his plans, believing that they would adopt a less rosy view of the world. Then he went further and gave himself a target of eliminating the structural budget deficit in 5 years, but his actual plans were forecast to achieve this in 4 years. His aim in all this was to maximise the expectation of the pain required in his deficit reduction plan and so minimise his chances of his plan not achieving their goals by the time of the next election. He was trying very hard to ensure that the economy and the reduction in the budget deficit actually came in better than expected in the later years of this Parliament, leaving him some scope for reining back on spending cuts or cutting taxes just before the May 2015 election.

The last year has not been kind to him. First the performance of the global economy has been much worse than was expected a year ago – this is not just the result of the mess in Europe, but also much weaker growth in the US and high food price inflation in many developing economies forcing them to slow their economies by raising interest rates – and this has contributed to a weaker than expected UK economy, making the job of reducing the deficit even m ore difficult. Secondly, the OBR made some key assumptions in its work that in hindsight were still too optimistic – they took the view that much of the reduction in tax revenues suffered in 2009 and 2010 was cyclical and thus short term rather than structural and so long term. Thus, they had tax revenues recovering quite sharply once growth got going again. This year’s deficit forecast is close to target, because there was little growth expected but the deficit forecasts for the next few years have had to be increased to account for weaker world growth and the OBR’s recognition that tax revenues from the banking system will not bounce back as fast due to the ongoing crisis and that weak productivity growth is likely to mean a slower rate of reduction in the unemployment rate.

In his first year then, Mr Osborne has not been seen as a success because he has had to reset expectations to an even lower level. From here though, it might just work out well for him. First, both he and Mervyn King have explicitly stated that all forecasts are dependent on the eurozone crisis being resolved fairly quickly, which is not unreasonable, and secondly that this time round it could well be that the OBR’s assumptions are too pessimistic in that they now assume that the loss of tax revenues were structural and long term and not at all cyclical and short term. Mr Osborne now has more pessimistic forecasts, for which he is criticised today, but which give him a greater capacity to produce a positive surprise, for which he can take credit, in a few years time.

For David Cameron, the bad luck may not be so easy to turn around. A successful resolution of the eurozone crisis requires much greater co-ordination of fiscal policy across the Eurozone. This will require tighter rules and international bodies with real power – in other words deeper political union amongst the Eurozone as Mrs Merkel has been saying for some time. The UK’s economic interests are clearly best served by a resolution of the crisis, but such a resolution is not, from a Conservative perspective, in the UK’s foreign policy interests. A deeper political union amongst the eurozone members, will lead to far larger and more powerful area, which will make policies affecting the UK but over which the UK will have little influence. It re-opens the European faultline within the Conservative Party, which Mr Cameron has worked so hard to paper over. The UK will have to make a fundamental reassessment of its policy towards Europe if the euro survives and a deeper, political union results. Such a debate has always proved to be very damaging for the Conservative Party.