As the UK prepares to head to the polls today, the country’s financial markets appear to be shedding their recent reputation for volatility.
British stocks are near a record high, bond fluctuations have evaporated and hedging against pound weakness is at a seven-year low. That marks a rethink by investors who imposed penalties on the country’s assets following the 2016 decision to leave the EU and then-British prime minister Liz Truss’ disastrous premiership of 2022.
The backdrop also suggests comfort with the likelihood that the election is going to hand power to the opposition Labour Party, whose traditional support for higher taxes and trade unions has historically put it at odds with markets.
Instead, the hope is that Labour leader Keir Starmer’s center-left platform can draw a line under a tumultuous period in British politics, especially at a time when volatility is growing in neighboring France and elsewhere.
“You could find the UK looking like an island of stability after 10 years of looking like the problem child in Europe,” said Shahab Jalinoos, global head of foreign exchange research at UBS Investment Bank in New York. “From the pound’s perspective, that’s a really good thing.”
Money managers at Franklin Templeton, Allianz Global Investors and RBC Wealth Management say they see UK assets as attractive compared with other places in Europe.
France is in the middle of a snap election in which the far right is projected to emerge as the largest party in its parliament, sending stocks to their lowest in five months and blowing out the risk premium on French bonds versus their German peers to the highest since 2012. That has burnished the appeal of relative-value trades that benefit from the comparative calm of the UK.
One popular expression is through the euro-pound exchange rate. The pound last month surged 0.5 percent to about ￡0.84 against the euro, briefly hitting its highest level in almost two years in the middle of the month.
While the euro recouped some of those losses in the wake of the first round of France’s poll, analysts at Barclays PLC see the pound rally continuing, with potential for it to reach ￡0.80 against the common currency — a level not seen since the Brexit referendum.
At the same time, the latest Bank of America fund manager survey shows that global investors favor the UK and Spanish equity markets, with France the least preferred; France had been the favorite a month earlier.
Stock investors are particularly bullish on homebuilders, as Labour has vowed to reinstate mandatory housing targets and ease planning restrictions.
With most polls showing a landslide win for Labour and a wipeout for British Prime Minister Rishi Sunak’s Conservative Party, the election is likely to be a “non-event” for markets, said Gregor Hirt, multi-asset chief investment officer at Allianz Global Investors.
His view is reflected in one-month volatility for the FTSE 100, which is hovering near its lowest levels of the year. In sharp contrast, swings in France’s CAC 40 shot up to its highest in more than a year in the run-up to the vote.
“We think the impact of the UK election is quite limited, mainly because it is a clear contest,” said Susana Cruz, a strategist at Liberum Capital Ltd.
That is just how investors want it in the UK following 14 turbulent years of Conservative Party rule, during which the country’s assets have danced to the tune of political drama.
Scotland’s referendum on independence, the Brexit vote and the years of fractious negotiations that followed caused wild gyrations in the pound.
Meanwhile, at the last general election in 2019, investors fretted over former Labour leader Jeremy Corbyn’s left-wing policies, including nationalization and worker stakes in companies.
On-and-off lockdowns to slow the spread of COVID-19, alongside the nation’s faster rollout of vaccines, also created market turbulence during the pandemic.
More recently, Truss’ package of unfunded tax cuts roiled markets in 2022 after a sudden rise in bond yields triggered forced selling from leveraged pension fund strategies. Gilts — government bonds denominated in sterling — plunged, forcing an extraordinary Bank of England intervention.
It is a sign of how far sentiment has shifted ahead of the election that David Zahn, head of European fixed income at Franklin Templeton, said in an interview on Bloomberg TV that gilts are “a safer place to be in than Europe at the moment.”
While that is a nice inheritance for Starmer — and for the Bank of England, which is preparing to lower interest rates in coming months — attention is likely to snap back to fiscal stability and the potential for economic growth.
Relentless messaging on fiscal discipline in the UK has left investors confident that Starmer and his pick for chancellor of the exchequer, Rachel Reeves, would not do anything radical on spending or borrowing. Both have also vowed to improve the UK’s ties with the EU, particularly in areas such as trade and immigration.
UK markets are also benefiting from the Bank of England’s slower pivot toward easing than the European Central Bank. Traders now see the odds of a first cut by the Bank of England next month as a coin-toss, even as the European Central Bank has already lowered its benchmark rate and is expected to do so again by October.
France’s National Rally party has also sought to assure investors that it would not upend the nation’s finances if it wins an outright majority, but the fiscal situation was already weighing on investor sentiment before the snap election was announced.
“There’s a wider range of unknowns in France at the moment compared to the UK, and that’s what puts the UK debt outlook, and our allocation outlook, slightly more positive than in France,” said Rufaro Chiriseri, head of fixed income for the British Isles at RBC.
The Canadian wealth manager is “slightly overweight” gilts, she added.
To be sure, the outlook for the UK even after a leadership overhaul is not exactly rosy. Starmer is inheriting stretched public finances and the worst decline in living standards in decades, and the Brexit premium weighing on UK assets cannot be expected to vanish overnight.
Some of the party’s manifesto pledges could also prove troublesome for certain sectors. For example, shares in North Sea oil companies fell after Labour announced plans for a windfall tax on the sector and ruled out issuing new oil licenses, with Serica Energy PLC and Enquest PLC most affected. A bid to take over Royal Mail-owner International Distribution Services PLC could also implode.
Jon Mawby, cohead of absolute and total return credit at Pictet Asset Management Ltd, said in an interview that long-dated UK sovereign debt is vulnerable to a selloff, given the next government is likely to have to increase public spending and issue more debt to deliver on campaign pledges.
However, most investors are betting that UK assets will provide a refuge in the coming months from political chaos elsewhere, particularly as the US hurtles toward a heated presidential election in November.
“Relative political stability around elections, strong and improving macro performance, a higher terminal rate,” Bank of America Corp foreign exchange strategist Kamal Sharma said. “There are clear reasons why markets should retain a short euro-sterling bias.”
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