Royal London UK Equity Income manager Martin Cholwill says political risk has been bubbling under the surface for some time and is likely to increase as the general election approaches.
The UK economy is growing quickly, with greater-than-expected capacity and muted inflation allowing the Bank of England to lengthen its interest rate normalisation, he says.
A lack of wage growth helps the retention of loose monetary policy but also prevents the pick-up of consumption, he adds.
Despite incomes remaining flat, there is movement on the other side with prices beginning to fall.
The Asda Monthly Income Tracker – a measure of discretionary income after tax and utilities – has increased for the 12th month in a row as prices fall and more people are joining the workforce.
“While it is early days, these tentative signs are encouraging: wages need to grow in order for the recovery in consumer spending to be sustainable,” Cholwill (pictured) says.
“Irrespective of wage growth, lower inflation also means there is some respite on falling living standards in the UK.”
Meanwhile, policies that butt against big utilities and tobacco keep flowing from politicians, particularly those on the left.
Labour has mooted a hike in minimum wage paid through stamp duty, a £750m levy on tobacco companies to pay for rapid NHS cancer testing, a price freeze for power companies and even the breaking up of the large retail banks.
And the polls show voters – who have seen shrinking pay for more than half a decade – are willing to support such moves with Labour posting 33 per cent, two percentage points ahead of the Tories last week.
“Politics remains a wild card in the UK as we enter an extended pre-election period,” Cholwill explains.
“The closeness of the Scottish referendum is a good example of how knee-jerk politics can work, with politicians offering large concessions on devolution to ensure a ‘No’ vote.
“We’re in a bit of a phoney war before the election. There’s a lot of kite-flying of policies at the moment and only a handful of those actually make it into manifestos.”
Axa Investment Managers senior economist David Page says the battleground is strange, with the most popular party distrusted on the economy and headed by Ed Miliband, a man most of the country does not favour as prime minister.
“The UK political landscape is febrile and the economic consequences of different permutations at the next election are far reaching,” he says.
“This spells a period where financial markets are likely to be highly tuned to political developments, threatening additional volatility for domestic markets.”
The Liberal Democrats have been pummelled by their supporters for concessions made to the right while in coalition and only command 8 per cent of the nation’s votes.
They have, however, U-turned on their opposition to a referendum on EU membership. If they return to power with the Conservatives, the LibDems are likely to “extract a significant political price” for their reversal, says Page.
Ukip is polling around 15 per cent as it appears to be gobbling up votes from both Labour and Tory ranks.
Its growing mass is beginning to warp the platforms of other parties, too, especially the Tories, who have begun toughening their stance on immigration and clashing publicly with the EU.
Whoever makes it to power next year will hold the helm for the largest constitutional change in a century, Page says, as devo max is rolled out to Scotland and the West Lothian question is dragged into the light once more.
They will be constrained by the budgetary deficit, which stands at 4.2 per cent of GDP. In 2010 it was a peacetime record of 11 per cent.
The Government’s tax receipts have failed to live up to expectations, making the public sector’s year-to-September borrowing swell to £58bn – which means it is £5.4bn more than a year earlier – to cover the shortfall.
Chancellor George Osborne’s pledge to balance the books in the next Parliament and give a £7.2bn tax cut is now looking decidely precarious.
And experts say he will have to make up the money from spending cuts, higher taxes or a combination of both.
“With markets already sensitised to the cost of political uncertainty with the Scottish referendum, we expect financial markets to be increasingly tuned in to political
developments,” says Page.
A British exit from the EU is a real risk and one that will start to impact business investment and hiring – and therefore markets – in the run-up to the election, he says, with exporters and financial services their most affected.
“Reduced investment intentions will likely soften the rosy outlook for corporate investment envisaged by the Bank of England and the Office for Budget Responsibility,” Page explains.
“We have already marked our own investment growth forecasts lower in 2015 to 8 per cent. This has added to our outlook for some deceleration in broader GDP growth over the coming quarters.”
Volatility will trend higher in coming months and be susceptible to swings in political polls, he says.
Strong Labour poll results will likely weigh on energy and tobacco stocks while Tory gains will be spread relatively evenly across the market, with exporters and financials getting a slightly larger boost, he says.
Standard Life Investments global thematic strategist Frances Hudson says the progress of Ukip could be a key determinant of policy across the parties.
“Certainly the Conservatives are reacting to Ukip rather than formulating a policy stance of their own.”
Recent Tory clashes with the EU over immigration are a “dangerous game”, she adds. “If Ukip hadn’t been standing there, a more conciliatory approach may have been taken. They’ve been pushed into adopting a more extreme stance than perhaps is really helpful.”
The political games paper over serious problems with the British economy that can only be addressed by reform and improving investment, she says. “Although there was a lot of talk of austerity, there wasn’t actually much austerity delivered. Perhaps a little more honesty about the path this will take is needed – these things can’t be resolved quickly.”
Recent global wobbles have already pushed back the Bank of England’s monetary normalisation, something that jars with the much-vaunted strength of the UK recovery, she adds. Labour’s rhetoric against the power companies is unhelpful, especially as they are the ones that future governments need to work with to improve the UK’s creaking generators, she says.
“If you’re beating them up on the one hand and you want them to be the people instrumental in creating these new better-built British power plants, that’s a problem – and the same goes for the housebuilders. Perhaps we need to take the politicians out of the equation.”