We do not have the uncertain outcome to the UK general election that pretty much everyone expected. A bit of market relief is understandable. But it is important to realise that none of the factors that will do most to shape Britain’s medium-term outlook was decided on May 7.
The first decisive factor is obvious but still too often ignored: the health of the global recovery. George Osborne learnt that the hard way as Conservative chancellor after 2010. Everything was in place for a revival in UK exports to make up for weak demand and fiscal austerity at home, including a 25 per cent depreciation in sterling, the biggest boost to UK competitiveness in living memory.
But none of that mattered, it turned out. Or at least, not nearly as much as the state of demand in our export markets — notably Europe.
UK exports grew, but not nearly as fast as imports. Growth disappointed overall, the trade deficit widened and a collapse in the UK’s external investment earnings meant that the current account deficit ballooned to the highest level since the 1980s. Instead of importing demand from overseas we ended up even more dependent on consumption at home.
This unhappy history should already have provided some comfort to investors worried that post-election uncertainty would play havoc with the value of the pound. But the lesson of the past few years is that the value of sterling is much less important to the state of the economy and the long-term value of UK assets than the state of global demand. That is especially true for Britain, where more than 70 per cent of UK-listed companies’ earnings come from overseas.
Call me crazy, but I think the rate of domestic demand growth in the eurozone in 2015 and 2016 will have a much bigger impact on the prospects for UK companies than the number of Scottish National party MPs in Westminster — or even the number of Conservative ones.
The second crucial factor is closer to home: productivity. If Britain does not start to see a recovery in its national output per head, then all bets are off — even for Mr Osborne — and the world will be tougher. It would mean that the economy would have lost 15 per cent of its potential output forever, and the average UK household will take many more years to make up the loss in real income they have suffered since 2008.
This question of productivity has been much debated here and elsewhere. If politicians had also focused on this issue in their campaigns and manifestos, we might have been able to draw a clear conclusion about how this surprising outcome will affect Britain’s long-term productivity. But they didn’t, so we can’t.
Some will argue that Labour would have been bad for productivity and entrepreneurship, because of Ed Miliband’s planned micro-meddling with the tax code and the environment for business. Others that these negatives would have been offset, over time, by Labour’s greater willingness to borrow to invest in infrastructure and skills. But few, I think, would argue that the choice between the two main parties on these key supply-side questions was clear-cut.
Not so on Europe. That is the third big factor shaping Britain as an economy and an investment destination — and one where there was and is a clear divide. Come hell or high water, David Cameron has assured us, a Conservative-led government will now hold a referendum on remaining in the EU by 2017.
Financial markets consider this the big negative to emerge from this surprising result. The concern about Europe was so great, for some business leaders, that they had supported Mr Miliband in the campaign, even as they complained about his plans for the energy sector or zero-hour contracts. But in reality, the choice between the two parties on the referendum really came down to timing, not outcome.
In the past five years, the likely future shape of Europe has changed dramatically and so have UK popular attitudes towards it. Both these developments will make it much more difficult for us to remain in the EU on the same terms as before. Sooner or later, we will have to choose what we want to have instead.
So, the question of Britain’s continued membership in the EU was going to remain on the agenda, regardless of who won power and how long they kept it. There could indeed be a short-term hit to investment in the run-up to the referendum. But other global forces may well matter more. It is not obvious that a referendum held in 2016 or 2017 is more likely to end in a UK exit from the EU than one held in 2020 — or even 2025. Nor can we say now which would cause more lasting uncertainty for business — or investment.
Our role in Europe, the growth rate of productivity and the state of global demand: on any reasonable timeframe, these are things that matter most to Britain’s economy and its markets. They were deeply uncertain before Thursday. Investors should realise that they remain deeply uncertain today.
The writer is chief market strategist for Europe at JPMorgan Asset Management
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