Snap reaction: Will the general election result affect the economy?

With almost all of the results now in, the scale of Labour’s General Election victory is clear. With five seats yet to be declared, projections suggest that Sir Keir Starmer’s party has won with a landslide majority of around 170, very similar to Tony Blair’s 179 seat victory in 1997. This overturns the Tories’ 80 seat margin of victory at the 2019 election.

Labour will have around 410 seats, having captured 34% of the vote, 2%pts more than in 2019. The Conservatives are now down to 119 seats. This falls short of the more extreme MRP polls during the campaign, some of which showed the Tories returning less than 100 MPs and even falling below the Liberal Democrats (which would have resulted in them losing the status as the main opposition party). This though is cold comfort for the Conservatives who now have the smallest total of MPs in their history. Several cabinet ministers lost their seats including Penny Mordaunt (Leader of the House of Commons), Gillian Keegan (Education), Mark Harper (Transport) and Grant Shapps (Defence).

The Lib Dems picked up 71 MPs, compared with 11 in 2019, the largest number since the party was formed in its current guise in 1988. It was also a historic night for Reform UK, returning 4 MPs. We note though that in terms of the share of the popular vote, Reform gained 14%, greater than the Lib Dems’ 12%. This discrepancy reflects the UK’s ‘first past the post’ system with the Lib Dems benefiting from a combination of concentrated support and anti-Conservative tactical voting.

Outgoing PM Rishi Sunak, who held onto his seat reasonably comfortably, conceded defeat on behalf of his party at his Richmond and Northallerton seat but is due to make a more formal concession speech later this morning. Current rumours suggest that he will resign as Conservative Party leader, but he may stay at the helm for a while longer, in order to oversee an orderly transition to a new leader. At this stage it is impossible to predict who the party will turn to, but of course the loss of so many cabinet ministers (plus several other senior MPs) narrows the available options.

Meanwhile Sir Keir Starmer will head to Buckingham Palace to see the King who will ask him to form a government. He is due to speak from Downing Street at around 12.20. We would expect Sir Keir to name his Cabinet ministers relatively soon, including Rachel Reeves as Chancellor. The formal appointment of the more junior members of the government typically follows over the next 24 hours or so.

We expect it now to be full steam ahead for Labour. But that momentum might be derailed if the current Parliamentary calendar is adhered to, with the Commons recess scheduled to start in less than three weeks’ time on 23 July. Reports suggest that Sir Keir is considering delaying this recess. Given that the King’s speech is set for 17 July, a 23 July break date would not allow for enough time for the six sitting days of debate typically needed to vote on it. As such, it is expected that the start of the summer recess will be pushed back a week to early August, to allow the Labour party to hit the ground running.

Financial markets keenly awaiting the new government’s fiscal measures will have to wait until the Budget though, which is expected sometime in mid-September/early-October. Before that point, it is possible that we will hear more detail on the changes to the fiscal rules than was laid out in the manifesto (there will no longer be an explicit deficit rule as a percentage of GDP, but rather day-to-day spending must be covered by tax revenues, a throwback to the ‘Golden Rule’ when Gordon Brown became Chancellor in 1997). Financial markets have punished those that have not been fiscally responsible in the past - the recent example was during Liz Truss’ 49 days in office in 2022. The current Labour party appears keen to avoid a similar fate.

Yet tough fiscal choices are going to have to be made. Sir Keir is staring down the barrel of real-term spending cuts for non-protected departments. Given that the current detailed spending plans only run to the end of this fiscal year, a new spending plan must be published in due course, but on the current ‘envelope’ there is a tight squeeze coming on departments outside of the NHS, education, defence and aid.

To avoid this fate the Labour leader and his Chancellor can a) increase taxes, b) borrow more, or c) grow the economy more quickly and thus tax revenues. The most desirable option is of course to boost economic growth, although realistically this is probably a medium to long-term aspiration. As such, facing cuts to spending, we expect Labour to raise taxes beyond those that were outlined in the manifesto. Changes to capital gains and inheritance tax may be on the table. We do not however, expect a breach of the manifesto commitment to not raise the four main taxes – income tax, VAT, National Insurance Contributions (NICs) and corporation tax. Given the substantial majority, the leadership should be able to push its policy preferences through the legislative process relatively easily without the need to accommodate fringe views within its own party.

But in all, although there has been a seismic change in government overnight, there is unlikely to be a seismic change in government policy over the next few years and we suspect that the overall stance of fiscal policy will remain unchanged. As such we do not see the Labour victory as a gamechanger for the path of interest rates and continue to expect the Bank of England to cut the Bank rate by 25bps to 5.00% at the next MPC meeting on 1 Aug.

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