The election outcome may be less clear-cut than headline polling data (which give Labour a ~20-point lead) suggest. Converting the May 2024 local election results into a ‘national equivalent vote’ sees Labour’s lead halve with a resulting hung parliament.

While some qualifications can be made to these projections (independent candidates typically perform better in local elections than in general elections) and the results do not include Scotland (where Labour is expected to make ~20 seat gains), they serve to emphasise that a much smaller Labour majority is a plausible and possibly under-priced outcome in markets.

How may markets view the different scenarios ahead of them? Our specialists share their opinions.

With a, say, 70+-seat majority in Parliament, Labour would have a secure base from which to carry out its plans – which we characterize as continuity in macroeconomic policy (fiscal rules and processes, monetary policy) but some ambiguity on the micro side (sectoral regulation, labour market).

Economically, the defining feature of the next parliament will be the tight inheritance on the public finances and the prospect of a multi-year fiscal consolidation if a Labour government is to meet the rule to lower debt in five years’ time. Delivering this will not be easy politically and is potentially sensitive to the size of the Government’s majority.

A centre-Left government may struggle to deliver a 2:1 ratio of public spending cuts-to-tax hikes fiscal consolidation. Higher taxes during the next Parliament seem more likely than not, absent a major upside surprise in economic growth.

Markets can expect a new government to deliver a full Budget in the autumn: possibly in September but more likely in October after the party conferences. There are some nuanced differences on Labour’s fiscal rules – which would allow higher borrowing for investment (the Conservatives’ rules cap overall borrowing). That may hint at slightly higher borrowing. Whether that approach would be justified hinges on how effectively any such borrowing for investment is deployed.

A credible fiscal policy stance would allow the Bank of England to cut interest rates. Whilst near-term sticky services inflation probably delays and lessens the interest rate cutting cycle, a tighter fiscal stance over the course of the next Parliament should allow policy rates to fall to ~4% from 5¼% at present. That, in turn, would facilitate business investment spending – in our view the macroeconomic priority for the UK.

The scope for closer EU ties may be limited in practice, at least in the near-term. Labour seems unlikely to adopt a more radical EU policy, having pledged not to re-join the single market or customs union. We do not expect any radical changes to the post- Brexit Trade & Co-operation Agreement (TCA) when it comes up for formal review in 2026 – the EU has no obvious incentive to materially later the terms of the deal.

For rates markets, if the central scenario of a sizeable Labour majority materialises (70+ seats, based on current projections), markets are likely not to move dramatically. Both parties will likely have a similar fiscal approach, and a change in fiscal policy would be what debt markets might worry about most with a change in power, especially from the traditionally more fiscally- Conservative Right to the Left.

That is not to say that markets should not be worried about the overall fiscal outlook. Indeed, the supply-demand imbalance in the gilt market is one of the key reasons that we expect gilt yields to remain high even in a rate cutting environment. Markets shouldn’t worry about this more if the election result yields a sizeable Labour majority.

If Labour wins with only a small majority (say 20-30 seats), markets might worry about fiscal slippage (and tax rises) as Labour might be forced to meet spending demands from its base to shore up sufficient support. This would imply a higher terminal Bank Rate, with higher yields and a steeper curve.

The impact on Sterling is framed by six factors: risk premium, interest rates, economic growth, current account deficit funding, EU relations, prevailing global macro-FX environment.

There is a reason why risk premium tops the list: under our base case, the currency seems unlikely to be impacted significantly given an unchanged economic outlook. But no battle plan survives the first contact with the enemy and elections are often no different. So, Sterling may be more volatile before 4 July than it has been recently as polling ebbs and flows. This volatility may increase if opinion polls were to narrow to be consistent with a hung parliament or small majority for either of the two main political parties. The relationship between polling and Sterling is thus expected to be non-linear. However, even then the impact is expected to be of orders of magnitude less than recent political events (such as the Scottish Independence referendum), Covid and European energy price shock.

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