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Markets rally with relief after the Conservative’s unexpected general election victory

A bad day for Labour, the Liberal Democrats and the pollsters resulted in an unexpected and convincing victory for the Conservative party in Thursday’s general election. “The election result provides us with yet another example of the folly of forecasting,” commented Kevin Murphy of Schroders. Shares and sterling surged as investors greeted the stability of an outright majority and the removal of political uncertainty. The FTSE 100 Index gained 2.3% on Friday, its biggest jump since January and swelling the value of British companies by £50 billion, to end the week up 0.87%.

Despite the optimism, attention turned quickly to the challenges ahead. The prospect of a referendum on Britain’s EU membership in 2017 has gone from a risk to a reality that could, in time, prompt some domestic and overseas investment to be delayed. Another reality is that whoever won the election has some hard work to do with the UK economy, and the Conservatives have pledged to eliminate the current budget deficit by 2017/18, which suggests a continuing tight rein on spending.

A renewed focus on austerity is likely to mean interest rates will remain lower than might otherwise have been the case. “The Tory government now faces having to improve these finances against the wishes of an avowed anti-austerity Scottish Nationalist Party that polled only 1.5 million votes but, due to the vagaries of the electoral system, ended up with 56 seats,” observed Nick Purves of RWC Partners. Neil Woodford shares concerns about the fairness of the political system and agrees that not all political uncertainty has been removed. “The performance of the SNP gives them a significant voice in parliament but no power. Question marks remain, therefore, about the viability of our constitution and the Union.”

“The landslide SNP result increases the possibility of a further Scottish referendum and the EU referendum will provide uncertainty”, added George Luckraft of AXA Framlington. “The paper-thin majority will be hard to manage with the bulk of the Conservative party to the right of David Cameron.”

Delayed due to Thursday’s general election, today’s meeting of the Bank of England’s Monetary Policy Committee kept interest rates on hold as expected. Since it was established in 1997, the MPC has avoided changing rates during any election months, but there remain few reasons for the Committee to take action. The UK avoided deflation in March – when the full impact of the drop in energy prices came through – and the first quarter’s GDP figure was weaker than anticipated. Wednesday sees publication of the latest inflation figures.

Bond blow-up

Midweek saw the worst bout of volatility in European bond markets since the eurozone debt crisis, as markets were thrown into confusion over the impact of quantitative easing on Europe’s financial assets and economies. The global fixed interest market lost £286 billion over the course of a week. Prices for benchmark 10-year German Bunds fell sharply, causing yields to jump as much as 21 basis points to 0.80% before settling back by the end of the week.

The sell-off in government bonds was accelerated when oil prices jumped to their highest level this year – at nearly $70 a barrel; a 50% gain from its January low of $46. The strengthening oil price encouraged expectations of higher long-term inflation rates and the end to a period of global disinflation. However, analysts cautioned that the surge could quickly run out of steam if US shale drillers boost production again, having struggled to break even when prices slumped. However, there are doubts that a rebound in oil prices to $60-70 a barrel represents a major threat to the global recovery. Even at these levels, prices would be well below the average of $110 (for Brent) that prevailed from 2011 to mid-2014, continuing to provide a boost for consumers. Brent oil ended the week at $65 a barrel.

Not too hot…

The release of the April US employment report at the end of the week prompted the bulls to take charge of Wall Street, after wariness earlier in the week on news that the country’s trade deficit had widened in March. The “goldilocks” report showed non-farm payrolls rising 223,000, while the jobless rate eased to 5.4% from 5.5% and average earnings grew just 0.1% month on month. Investors took these combined factors to indicate that the economy is warming up steadily, but without the heat that might lead the Federal Reserve to raise interest rates sooner. The news helped calm concerns triggered by the extreme volatility in European bond markets earlier in the week. The S&P 500 Index ended the week up 0.36%.

Synonym overload

As thoughts turned to a referendum on ‘Brexit’ and the prospects for ‘Scoxit’, so the ‘Grexit’ saga continued to play out. Greece reportedly scraped together enough cash on Wednesday to repay an International Monetary Fund loan of €200 million, but another repayment of €750 million is due on Tuesday this week.

The Eurogroup of finance ministers meets in Brussels today to wrestle with the Greek crisis, but officials said there is no prospect of a deal being reached then to free up the further €7.2 billion in bailout funds, despite the claim of prime minister Alexis Tsiparis that, “We will soon have a happy ending”. Time is running out on the 30 June deadline for the final element of the €240 billion bailout programme begun by the eurozone and the IMF in 2010. The Greeks were said last week to have made concessions over reform of their VAT system, but dug their heels in over wages policy and pension cuts. Athens also announced it was rehiring civil servants fired as part of the public spending cuts enacted by the previous government.

Greece’s task was further complicated by news that the European Commission had drastically slashed its growth forecasts for the Greek economy, predicting expansion of only 0.5% of GDP, down from a robust 2.5% projection three months ago. Such a scenario of deteriorating public finances could require Athens to accept an even more demanding reform agenda to get back on track, and would increase the likelihood of its eurozone creditors needing to write off some of their bailout loans.

After hitting an eight-week low on Tuesday on concerns over developments in Greece, the Eurofirst 300 Index ended the week up 1.26%, boosted significantly by Friday’s election result and the removal of short-term uncertainty.

What next?

The general election result lessens the likelihood of an emergency Budget, as the Tories’ plans are not too different from those of the coalition, and clears the way for the implementation of proposals set out in March’s Budget. These include a reduction in the pensions Lifetime Allowance to £1 million from April 2016, the introduction of the new Personal Savings Allowance, and the ability for individuals to sell their annuity.

It also signifies a continuation of the Conservative theme of personal responsibility, which extends to the need for individuals to take the necessary steps to create and maintain wealth, seeking advice where appropriate.

The Conservative pledge to freeze Income Tax, VAT and National Insurance rates for the term of the next parliament raises questions over what other measures the new government can introduce to meet its fiscal targets. It remains to be seen whether the new government honours its manifesto pledge to introduce a new Family Home Allowance to increase the Inheritance Tax threshold for couples to £1 million where a family home is included.

Once the initial euphoria that greeted the election result settles down, investors’ attention will turn from local politics to the global matters that are the principal drivers of markets. “The UK market is a global one,” advises Luke Chappell of BlackRock. “Whilst there may be some short-term share price moves, global economic growth, US interest rates and energy and commodity prices, are far more important to UK equity investors. With shorter term political risk reduced, focus may again turn to these medium to long term drivers.”

Words by Tom Williams. Tom has vast experience in trading the Forex markets and is a qualified financial advisor. With expertise in wealth management, retirement planning and inheritance tax planning, he regularly advises on how to maximise personal wealth.

To receive a complimentary guide covering Wealth Management, Retirement Planning or Inheritance Tax Planning contact Tom Williams on 0777 910 5434 or email tom.williams@sjpp.co.uk.

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