On Friday, the pound, British stocks, and government bonds saw gains following a significant victory by the centre-left Labour Party in a parliamentary election.
The FTSE 100 index increased by 0.38% at the opening, while midcap stocks rose by 0.4%. The yield on 10-year British government bonds, known as gilts, fell 3 basis points to 4.17%, aligning with other European markets.
Sterling climbed nearly 0.1% against the dollar, reaching $1.2777 by 0708 GMT, and remained stable against the euro, which stood at around 84.75 pence.
Labour achieved a commanding majority in the 650-seat parliament, with Rishi Sunak’s Conservatives experiencing their worst performance in history due to voter dissatisfaction over the cost of living crisis, failing public services, and multiple scandals.
“A landslide victory provides the sort of clarity and stability that equity markets need in an increasingly volatile world,” said Ben Ritchie, Head of Developed Market Equities at abrdn. “If the new government gets this right, businesses with significant exposure to the UK economy should be the likely winners, particularly companies in the FTSE 250 and FTSE Small Cap.”
Since Sunak called the election in late May, earlier than expected, sterling has edged up. It has been the best-performing major currency against the dollar this year, with a 0.3% gain. On a trade-weighted basis, the pound is now back to its 2016 level, reflecting traders’ and investors’ belief that a period of market volatility under the Conservatives may be ending.
“We knew Labour would win, so this doesn’t change much for sterling. Now, we want to know Labour’s plans,” said Kenneth Broux, head of corporate research for FX and rates at Societe Generale. “Investors have been long on sterling, and the results won’t change that sentiment.”
Reflecting pre-election calm, the risk premium for holding gilts over top-rated German 10-year bonds has remained stable around 160 basis points this year, far from the 230 bps seen during the 2022 mini-budget crisis.
UK stocks have hit record highs this year, supported by a slow-growing but stable economy and decreasing inflation.
However, the memory of the market chaos triggered by former Prime Minister Liz Truss’ “mini-budget” in September 2022 is still fresh, and Britain’s strained finances will limit the new government’s spending capacity.
Truss lost her parliamentary seat in Thursday’s election.
“Labour has pledged significant spending but only has around £20 billion of fiscal headroom, so balancing the books is a key question,” said Pepperstone senior research analyst Michael Brown. “Labour’s plan for 2.5% annual GDP growth is ambitious, and if not achieved quickly, significant fiscal tightening could occur.”
In recent years, Britain has faced high inflation and interest rates among developed nations. UK 10-year government bond yields have risen to around 4.2% this year as investors anticipate British interest rates will take longer to decrease.
The Bank of England is expected to lower interest rates in either August or September. Analysts suggest that investors will soon shift focus from the election results to monetary policy.
“There’s limited room for dramatic fiscal policy changes,” said Fiona Cincotta, senior markets strategist at City Index. “So, market movement will likely hinge more on the Bank of England’s actions than the election results until the Autumn Statement.”
