The UK Election and the Economy

Whichever party, or combination of parties, forms the next UK government, will face the same economic conditions.

By and large those conditions are fairly good. This is the right stage of the economic cycle for a government to be taking office.

The UK has seen the policymaker's dream of accelerating growth and falling inflation over the last 18 months. The long squeeze on UK consumers has drawn to an end: real incomes are rising and the cost of borrowing is very low. On average, economists see the UK growing by 2.5% this year and next, a decent rate of growth which is towards the top of the European growth league.

There are risks. US activity data have been on the weak side of expectations since the start of the year. Three months on from the election that swept Syriza to power, Greece's future in the euro area remains uncertain. At home UK growth came in disappointingly weak in the first quarter, prompting concerns that the UK recovery is running out of steam.

Yet on balance we think the UK recovery has pretty good momentum.

Quarterly GDP data are choppy and prone to revision and our hunch is that the first quarter UK slowdown was an aberration. Softer data from the US similarly seem to us to be one of those periodic weak patches. The outlook for growth in the euro area has improved since the start of the year despite the rumbling Greek crisis. Financial markets, perhaps optimistically, seem to think a Greek exit from the euro area would not trigger a break-up of the whole system.

Our sense is that the UK's problems lie closer to home.

Concerns about the General Election seem to be behind a decline in corporate risk appetite and rising perceptions of uncertainty in the latest Deloitte survey of Chief Financial Officers. CFOs worry about the risks of higher taxes, more regulation and potential withdrawal from the EU.

While we think the UK recovery is pretty solid it could yet be derailed. And in the longer term UK faces the challenge of poor productivity and high levels of government borrowing.

The experience of the current Coalition sheds light on how the next government could start to tackle these challenges.

Before the last General Election the scale of UK public borrowing was a major concern for markets and for business. We tend to forget, but the worry then was that high levels of borrowing could push the economy into a new financial crisis. In our pre-election CFO Survey, in April 2010, 85% of Chief Financial Officers said deficit reduction should be the new government's top economic priority.

On taking office the Coalition put deficit reduction at the heart of their strategy. Markets duly reacted. Talk of the UK's credit rating being downgraded subsided and the price of UK government bonds soared.

The paradox is that the Coalition missed their deficit reduction targets and the UK deficit, though halved from the levels of five years ago, is still one of the largest in the industrialised world.

The lesson is that in economics intent matters. Fears about the UK deficit were assuaged by a belief that the Coalition was committed to debt reduction. The euro crisis and a disappointing trend in tax receipts contributed to the failure to meet the deficit target. But markets have remained fairly sanguine, in part because they think the government is serious about deficit-reduction.

And the message for the political parties this week?

The recovery should not be taken for granted. CFOs' expectations for investment are already flagging. Given that growth is dependent on the private sector, policymakers need to be acutely sensitive to the effects of their policies on business confidence.
Business is nervous about political uncertainty and business-hostile policy change. A strong signal that the new government is committed to pro-growth policies and to stability could help ease such fears.