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imageCalling the shots? Markets take stock.Andy Rain/EPA

The post-election rally on UK financial markets was as much a celebration of Labour staying out of power as of the Conservatives regaining it. Labour had scared investors in key sectors with manifesto promises to freeze energy prices until 2017, increase the bank levy, ban zero-hours contracts and raise the National Minimum Wage (currently £6.50 per hour) to over £8 by October 2019.

These were policies that could have dented profitability in a number of sectors including those most represented on the stock market. These discomforts to business were compounded by planned extra demands on those who earn most from it, notably a restored 50% tax rate on incomes over £150,000, tougher rules for landlords, and a mansion tax.

Some retreat from markets' initial upswing is likely in the next few days, as investors reflect further on the nature and causes of Conservative victory. David Cameron’s majority is even smaller than the one gained, equally surprisingly, by John Major in 1992 – a disconcerting precedent for a government that must steer “renegotiated” EU membership terms past some powerful Eurosceptics, then through a referendum, in order to lift the threat of Brexit.

Balancing act

Just as efficient markets are not supposed to let history repeat itself, investors currently seem confident that the Conservatives will learn from the defeat that ended Major’s tenure, and maintain parliamentary unity at least until the referendum is won. But unruly backbenchers aren’t the only ones whose voices are amplified by a wafer-thin majority: the lobbyists that Cameron promised to tame are anticipating increased influence now that persuading a small number can swing a parliamentary vote.

imageAn unhelpful precedent.Chatham House, CC BY

Whether the notoriously “short-termist” markets’ morning-after rise reflects firm belief in the longer-term outlook is harder to judge. The swing towards the Conservatives (outside Scotland) was motivated in part by an economic recovery that remains far from balanced, uncomfortably reliant on consumer spending and the further growth of household and government debt until the long-delayed revival of business investment.

In its golden scenario, the new government has arrived just as Eurozone markets come back to life, China arrests its slowdown and UK productivity bounces back, enabling income growth which slaps down that resurgent household debt ratio. This generates the faster GDP growth that now appears essential to deliver on a manifesto that conjured a win from some ambitious promises. The new government wants to move the budget into surplus while cutting taxes and ensure that “public investment will be higher on average over this decade, as a percentage of GDP, than under the whole period of the last Labour Government”. Infrastructure spending is earmarked at more than £100 billion in the next Parliament.

Not all sunshine

There is a leaden alternative scenario under which last year’s 2.6% GDP growth is as good as it gets and the economy slows again as fiscal stimulus is withdrawn with no scope for further monetary relaxation, while a renewed rise in world interest rates and oil prices rules out export-led growth. Were this to happen, those election-winning fiscal promises – more eye-catching and vote-grabbing than Labour’s – might start to seem too good to be true.

imageEngine of growth?Badly Drawn Dad, CC BY-NC-ND

The same 2008 crash that drained Labour’s economic credibility also highlighted the role of London’s financial centre in driving the economic imbalances that eventually gave them cause to collapse. The UK’s longstanding excesses of public spending over tax revenue, investment over saving and imports over exports has been financed by equally persistent inflows of capital, via direct or portfolio investment. Foreign investors' targeting of the UK for its ability to outgrow the Eurozone contains an element of self-fulfilling expectation, the catch being that market expectation can rapidly and not always rationally change.*

Capital inflow bounced back impressively after 2008, helping the government to finance its rising debt at low cost and ensuring that the widening current-account deficit did not constrain the eventual recovery. But a recent global slowdown of cross-border investment flows, if it continues, could put the brakes on recovery unless this quickly becomes more investment-driven.

Rowing back

Even if it can be implemented without internal rebellions,the Conservatives’ renewed “one-nation” approach stops its agenda being entirely business-friendly. An attack on “aggressive tax avoidance and tax planning” is expected to yield £5 billion of the £30 billion fiscal consolidation promised for the next two years and plans to “make sure our financial services industry is the best-regulated in the world” already strike some as too onerous to keep the City thriving.

Market players who celebrated after the count will be hoping that some of these pledges served only to defuse political opposition in England and Wales – and can be diluted dilutable now that victory has been achieved. If the new government means all that it says, the long tradition of financial markets doing better under the Conservatives may now be put to the test.

Alan Shipman does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.

Authors: The Conversation

Read more http://theconversation.com/financial-markets-uk-election-elation-could-falter-on-brexit-and-budget-fears-41532

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