How will gilts react to a change of presidency within the UK?

Official polling suggests Britain is on course for a change of Government next week after 14 years of Conservative Party rule, and the new leadership is tasked with dragging the economy out of the doldrums.

Labour looks set to win a historic victory, and Keir Starmer’s party has vowed to deliver the highest sustained economic growth in the G7 ‘with good jobs and productivity growth’, all while turning Britain into a ‘clean energy superpower’.

But whoever wins on 4 July will do so in the shadow of Liz Truss’ disastrous 2022 mini-Budget, and the havoc its unfunded tax cuts unleashed on the nation’s finances – as well as the personal finances of its citizens.

So how will debt markets react to a change in Government and can Britain revitalise its economic fortunes while avoiding another market meltdown?

Labour Party leader Sir Keir Starmer and shadow chancellor Rachel Reeves have been keen to emphasise fiscal responsibility in the party’s manifesto  

Gilts in vogue

Retail investors have piled into gilts – or UK Government-issued debt – since the start of the year, attracted by a solid yield and an expected increase in the value of the bonds as interest rates begin falling later this year.

Hargreaves Lansdown said in April that first quarter gilt purchases on its platform were three times higher than the same time last year, while Interactive Investor saw its best month for gilt sales in 10 months.

Private investor appetite has primarily been for short-dated gilts – those that mature within a few years – where there is greater clarity on the direction of interest rates and a shorter time horizon to receive the full value of their investment returned.

Demand for the bonds has increased as base rate has peaked and the Bank of England’s first rate cuts come into view.

The price of a bond rises and falls inversely to its yield. Two-year and five-year gilt yields have fallen by 91 and 52 basis points, respectively, over the last year.

With two-year and five-year yields now at 4.2 and 4 per cent, respectively, they are comfortably below their post-Truss peak.

Analysts say the UK has done a good job of rebuilding the confidence of bond investors after Liz Truss’ market meltdown in late 2022

Manifestos met with a shrug

By contrast to the Truss era, when moves made in Westminster induced the ire of bond vigilantes, markets have been largely unfussed by the publication of party manifestos ahead of the General Election.

Two-year and five-year yields have fallen 27bps and 16bps, respectively, over the last month as longer-term yields have also dropped. 

But analysts say this is driven by expectations of looming interest rate cuts, rather than in response to political promises. 

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: ‘So far, pledges and promises made do not seem to have perturbed the debt markets, with the yield on 10-year and 30-year UK gilts falling back over the past week, [and] bond investors appearing to be more sensitive to interest rate speculation than the investment plans of an incoming government.’

Politicians – they’re all the same!

But the absence of an overtly negative reaction to either the Tory or Labour manifestos can at least partly be credited to each party’s restraint on the generosity of their respective pledges.

The Conservative government and Labour’s shadow chancellor Rachel Reeves have both committed to so-called ‘fiscal rules’, which require debt as a proportion of GDP to be on track to fall over a five-year parliamentary term.

Fredrik Repton, senior portfolio manager at fund house Neuberger Berman, said that both current Chancellor Jeremy Hunt and the BoE have done a ‘good job’ of rebuilding investor confidence in the UK via more constrained policy and effective market communication.

Both parties will be keen to avoid damaging that confidence.

Tom Becket, co-chief investment officer at Canaccord Genuity Wealth Management, said: ‘Because of the teetering and ever-growing debt pile that has been amassed by our governments over the last 30 years, we don’t have the financial or fiscal wiggle-room for ‘out of the box’ policies.

‘Thankfully, the Labour manifesto looks pretty steady. The ill-fated Liz Truss administration was a clear reminder of the practicalities of overseeing our country in its parlous financial position.’

Comparing the economic growth performance of previous Labour and Tory governments 

A ‘changed’ Labour and its critical first budget

As part of efforts to demonstrate Labour’s new-found commitment to fiscal responsibility, Reeves has dropped a £28billion-a-year green investment plan that just a few months ago formed the bedrock of the Labour party’s offering to the British public.

Reeves and Starmer have also made no attempt to hide their efforts to cosy-up to the City, with Labour keen to shrug off its Corbynite recent past in the eyes of markets.

Neuberger Berman’s Repton told This is Money that debt markets don’t currently see any major difference between Britain’s two main parties.

He said: ‘That’s why we’ve seen markets being so sanguine about the election.

‘We manage bond funds – we’re not political analysts. But as we look at this, we don’t see any material difference, at least at first glance.

‘We expect the Labour Party to be reasonably conservative in the way that they communicate with markets too.’

Sterling has performed worst against the dollar when Labour are in power 

However, Repton cautioned: ‘There’s always the risk over time that discipline deteriorates to some degree’ and Labour’s first budget ‘is going to be very important’.

While both Labour and the Tories have been keen to talk up their own fiscal responsibility, they have also be conspicuously vague on their taxation plans.

Both have ruled out hikes to the state’s key revenue drivers – income tax, national insurance and VAT – while denying they’ll institute increases elsewhere.

This is despite most economists agreeing the tax take will have to rise over the next parliament, even to meet current spending and debt repayment responsibilities.

Repton said: ‘This is something that would have to be addressed at some point, regardless of who wins the general election.’

Does the colour of the rosette even matter?

Research from investment platform eToro suggests 44 per cent of retail investors believe a Labour win at the general election will be a bullish sign for Britain’s stock markets, while 30 per cent say the opposite.

Canaccord GWM’s Becket said that international investors ‘could breathe a sigh of relief at the changing of the political guard’ after a period of stagnation for Britain.

But analysis from funds giant Vanguard suggests that the UK stock market has been fairly unmoved by elections in recent times.

Vanguard data shows the seven general elections that have taken place between January 1995 and December 2023 ‘had a minimal impact on stock market performance’.

It added: ‘The events that impacted the stock market the most were of a much bigger, global scale.

‘These included the bursting of the dot-com bubble (when technology stocks fell after a rapid rise in valuations in the late 1990s), the global financial crisis in 2007-09 and the Covid-19 pandemic in 2020.’

Vanguard data shows general elections have generally had little impact on the outlook for UK stocks 

And longer-term analysis conducted by chief economist and head of research at Panmure Gordon, Simon French, suggests that the policy difference between Labour and Tories isn’t as stark as many voters might think.

French said: ‘The quarterly GDP records of Conservative and Labour led governments are nearly identical.

‘There is no historical evidence – at least since reliable GDP data became available – that Conservative or Labour governments are better, or worse, for the growth of the UK economy.

‘Turning to fiscal policy and this is probably the finding that is most at odds to the prevailing commentary/ conventional wisdom. Since 1955 fiscal deficits have been of a modestly smaller size under Labour governments (2.9 per cent of GDP) compared to Conservative governments (3.3 per cent of GDP).

‘The other aspect to consider for capital market participants is the strength of sterling under different administrations.

‘On average the long-term softening of GBPUSD over the last 70 years has been more pronounced under Labour governments (-0.26 per cent Quarter-on-Quarter) than under Conservative led governments (-0.16 per cent QoQ).

‘These are relatively small differences however, and it is difficult to establish a pronounced difference in currency performance amidst a general devaluation trend.’

Since 1955, fiscal deficits have been of a modestly smaller size under Labour governments than under Conservative governments