There is a real risk that the UK will experience another change of prime minister. If this happens, it would be the fifth PM since 2020. The previous five prime ministers, starting with John Major in 1990, managed a total 30 years in power.
For most of this period, economic policy has been uncontroversial. Even in the global financial crisis (GFC) and Covid-19 pandemic, there was unanimity between markets and politicians as to the suitability and thus stability of policy.
This was only briefly broken by the 44 days of the Liz Truss government, which in doing so re-enforced the norm. Historians and commentators have described this consistency as ‘Treasury orthodoxy’.
So why would a change in prime minister alter the path of economic policy? The polarisation of UK politics and its volatility is witnessed by the revolving door of prime ministers. Given the Labour Party majority, we need to examine the potential policy options a new PM would have, rather than the outcome of a new election.
There are two strands competing for the job: the continuity candidate or the popular (with the party) candidate.
Continuity candidate
The most recent Budget set out a very clear road to an election in May 2028. A degree of fiscal loosening that would be offset over time by rising personal and wealth taxes. Most of these tax rises occur in 2028/29.
Whilst the priority for spending may change – some departments benefitting, some losing from where they stand – it will effectively be old wine in new bottles. The chancellor may remain the same, but in this circumstance, it is less important.
However, if under pressure the continuity candidate may well find themselves driven to adopt some measures that the popularist candidate (listed below) would pursue.
The popular/party candidate
The inability to drive growth and reorder the economy has been at the heart of the frustrations of the popular, left-leaning instinct of Labour. Thus, a candidate from the left would aim to have a real impact on the economy and its direction.
Expect significant intervention in markets that are perceived to be working poorly, such as housing. Expect a significant release of funds for policy priorities such as education, health and social care.
The commitment to Office for Budget Responsibility (OBR) rules may well end and we could see changes in senior officials. For instance, Andrew Bailey’s term as governor of the Bank of England ends in March 2028.
If we look at some of the proposals that were rejected for the last Budget, we may see some obvious policy options: capital gains tax on homes, increasing bank tax, caps on ISA ownership, dividend taxation at the rate of income tax, National Insurance payments by working pensioners, stamp duty for commercial property and reductions in VAT threshold for small business. These alone would raise around £20bn, but would particularly impact savings and wealth
But there are further options: a wealth tax of 2% on sums over £10m per person has been modelled as yielding £24bn, even with a significant exodus of the 20,000 individuals caught by this.
A rise in higher-rate income tax to 50% would yield about £1-2bn a year. All of this would also suit the political atmosphere. Perhaps even an increase in corporation tax and taxation of private equity gains.
From a social policy perspective, expect further renters’ and workers’ rights, rising minimum wages and a rebalancing of the union rights.
The taxation of social media/gig economy, as well as tighter controls, would also be likely.
Market reaction
How would the market react to this? Clearly, the pound and UK gilts would come under pressure, particularly as the threat of further debt issuance by the government looms. But it is possible that with substantial tax increases – we have listed over £40bn of tax increases – the new government would have something of a runway.
The real impact would be on equities and the small and mid-cap (SMID) sector. The sensitivity of SMIDs to rates is well known and fiscal spending is likely to choke off rate cuts.
Our work shows that SMID correlations to other, broader economic factors are high as well, in particular to total employment, retail sales, the retail prices index (RPI) and exports. If higher taxation were to slow the rate of growth, these high-correlation indicators would suggest pressure on these sectors.
At the same time as the rise in employment costs, we could see the acceleration of the use of artificial intelligence (AI) by businesses to reduce government-driven wage increases. As such, total employment would become a key indicator.
There could also be moves to reintegrate the UK with the European Union. All the cabinet members of today who were MPs in 2016 were supporters of Remain.
This could have a major impact, particularly on economic credibility, if the UK were to sign up for the single currency, as new joiners must do.
Current market sentiment
Currently, the markets are sanguine. They are looking at this risk as something in part known and in part examined. Much of the domestic and foreign selling of the equity and gilt markets has already occurred.
But the discount that UK assets have to the world would be reinforced, leaving the currency to take the strain. The electoral cycle means that this new government would have only a couple of years to last.
So, the concern would be: what comes next? That’s when it would get radical.
Michael Browne is global investment strategist at Franklin Templeton Institute. The views expressed above should not be taken as investment advice.