UK markets have rallied strongly this morning after the general election has unexpectedly delivered a single party majority. Coming into the UK election, the polls were suggesting that neither of the major parties (Conservatives and Labour) would come close to generating an overall majority. That would have meant weeks of political horse trading and concurrent policy uncertainty. Today’s rally is a reflection of that political risk being reduced.
Now that the electoral uncertainty is behind us, the UK economy looks well set to sustain real growth of 2.5%–3% over 2015. Inflation is already comfortably below the Bank of England’s (BOE) target of 2%, and is likely to remain so over 2015 and 2016. Employment growth remains strong, and for the first time in five years wage growth is outstripping inflation. The business community should be reassured by greater political stability at home and better growth in the UK’s largest trading partner, the eurozone.
Further ahead, political risks remain, not least Scotland’s relationship with the UK and the UK’s relationship with the European Union (EU). Greater devolution of power to a resurgently nationalistic Scotland had already been agreed during the Scottish referendum last September. So the new news today relates to the prospect of a referendum on EU membership by 2017. How that discussion develops will be a subject of much debate in years ahead. So far, the UK’s enthusiasm for EU membership seems to be dominated by the outlook for the eurozone. Given improving prospects for the eurozone, the threat of the EU referendum should not derail the UK recovery. Today’s rally in UK assets makes sense.
We should now be able to refocus on medium-term prospects for growth and inflation. Both look good – above-trend growth but below-target inflation mean no imminent rate hikes by the BOE, certainly this year and potentially well into next.