Post-election rally likely to be short-lived

A Tory victory raises the prospect of a continuation of tight fiscal policies, bolstering the UKs safe haven status. Picture: AP

Investment markets responded well to the Conservative victory in the general election, having priced in expectations of an inconclusive result that may have been followed by weeks of political instability.

The pound rose sharply against the dollar on Friday morning and the FTSE jumped as shares in banks, energy companies, housebuilders and estate agents surged. Meanwhile the yields on ten-year government bonds (gilts) fell to a six-month low as investors viewed the prospect of tighter fiscal policies as bolstering the UK’s safe haven status.

But experts predict that, with concerns lingering over the strength of the economic recovery and an EU referendum now firmly on the agenda, the rally will be a temporary one.

The Tory win and the SNP success north of the Border is also seen in some quarters as increasing the likelihood of another referendum on Scottish independence.

David Thomson, chief investment officer at VWM Wealth in Glasgow, said: “There appears to have been a shift to the left in Scotland and a shift to the right elsewhere which may create political tensions going forwards,” he said. “It makes a difference in the income tax rate between Scotland and the rest of the UK even more likely, while the fiscal transfers between Scotland and the UK will probably come under further review.“

The “relief rally” in the pound and equities will last a little while longer, according to Thomson.

That the changes announced in George Osborne’s March Budget will now be implemented without U-turns and the uncertainties of “hybrid” coalition policies have been removed will boost the UK’s stability in the eyes of investors. But it won’t “all be plain sailing”, he warned, as the Conservatives embark on spending cuts that will probably “keep a lid on UK economic growth in the next couple of years”.

The bad news for long-suffering savers – and the good news for many homeowners – is that interest rates may stay lower for longer as the austerity programme keeps a lid on inflation.

Alec Stewart, chief executive of Anderson Strathern Asset Management in Edinburgh, said: “Politically, this result will be seen as a mandate for the Conservative Party to continue with its austerity programme. In that fiscal environment we would expect to see lower interest rates for longer, perhaps into quarter two of 2016, as the UK government tries to balance the books.”

But the outlook for the UK economy is now overshadowed by the Conservative policy to hold a referendum on EU membership in 2017.

“This will create further uncertainties, and big business in particular will not be keen on a withdrawal; putting their spending plans on hold while they await the outcome will constrain UK economic growth,” said Thomson.

“This whole process may drag on as the Conservatives will enter into negotiations with Europe and that will not be a quick process.”

Stewart also singled out the EU referendum as a concern for investors. “With a referendum on Europe now on the horizon, the surge in the pound is probably a short-term ‘relief rally’,” he said. “Uncertainty over the UK’s future in the EU will be a consideration in the months to come and could threaten the confidence we are seeing.”

The UK’s best known fund manager, Neil Woodford, of Woodford Investment Management, sounded a similar note of caution. Woodford, who previously ran the massive Invesco Perpetual income funds, said the UK economic outlook is “somewhat subdued over the next five years”.

“A less conclusive result would clearly have been worse for the  economy because of the associated political uncertainty, but our assessment of the UK economy suggests  we should expect modest growth at best over the next few years,” said Woodford.