Call Participants

ATTENDEES

Jan Gerhard

Raj Badiani

Chris Rogers

Kristen Hallam

Presentation

Kristen Hallam

You're listening to The Decisive Podcast, insights and analysis to empower confident decision-making. Welcome to The Decisive Podcast. I'm your host, Kristen Hallam, Lead Content Strategist for Global Intelligence and Analytics.

Today, I have my colleagues from S&P Global Market Intelligence, Jan Gerhard, Raj Badiani and Chris Rogers joining me to discuss the new U.K. government and what it means for the economy, trade and EU relations. Jan is a Senior Analyst for Country Risk in Europe, based in Germany. Raj is an Economics Director specializing in Europe, based in the U.K. And Chris is Head of Supply Chain Research, also based in the U.K. Thank you all for being here.

Jan, what was the outcome of the election? And how did we get here after 14 years of Conservative leadership in Parliament?

Jan Gerhard

So the Labour Party led by the U.K.'s new Prime Minister Keir Starmer achieved a landslide victory in the 4th of July general election. It secured a large majority in the House of Commons, an additional 211 seats, which is a lot. And which leaves the Labour Party with 412 out of the 650 members of parliament.

The Conservative Party, now the largest opposition party, dropped sharply under the leadership of former Prime Minister Rishi Sunak, leading it to its worst election result in history by losing 251 seats. And now the Conservative Party only has 121 MPs in parliament.

So how did we get here? The U.K. has, in fact, experienced several years of heightened political instability already, driven by major events such as Brexit, early elections, unscheduled changes of prime ministers, but also unforeseen issues, of course, such as COVID and, indeed, external factors, including multiple global economic and security challenges.

It appears that many voters now, in the most recent election, felt like the Conservative Party has indeed failed to handle these multiple challenges appropriately or they were just looking for substantial change overall, and that, ultimately, helped the Labour Party to secure such a decisive victory. There's actually more to this narrative because the U.K.'s political system is undergoing quite a few structured changes.

And most notably, the increased diversification of votes across the political spectrum is driving the U.K. further away from the political system traditionally dominated by the Conservatives and Labour as the 2 major parties. Meaning that parties often fail to translate their share of the vote into actual parliamentary representation. The smaller parties often find it more difficult to garner support overall.

I would argue that these dynamics are really crucial in assessing where the U.K. will go from here. And particularly, as quite a large share of electorate is likely to remain frustrated and/or doesn't really feel represented in the current parliament. Starmer's administration will be held to account by very different types of voters from the left, the right, the center. And that will surely have an impact on policymaking in the new term and also actually, further beyond.

Kristen Hallam

Jan, what does all of this mean for political stability in the U.K.?

Jan Gerhard

So a decisive change in government naturally has a clear impact on policy direction across a broad array of legislative areas. The U.K. will, of course, see regulatory change. Overall, political risk in the U.K. has clearly decreased, which is, for instance, likely to be helped by a much more harmonious and coherent government.

Labour's clear single-party parliamentary majority makes the new government powerful in Parliament, and Starmer will probably be able to advance preferred policies without major difficulty throughout the new term. This, in itself, is likely to ensure a degree of legislative stability, and that goes as long as the administration remains largely united.

And I think that is probable and that will be the case for the first half year, maybe the first year. However, we mustn't forget that there are also very different factions within the Labour Party, and that future internal divisions over all sorts of legislative initiatives can indeed lead to conflict.

I don't think that we're going to see the repeat of the constant government infighting that has hampered policymaking over the last few years. But one should definitely bear in mind that intragovernment disputes will probably also emerge eventually in the near term.

Kristen Hallam

Can you remind us, what were the main promises that the Labour Party made in the campaign?

Jan Gerhard

Let's maybe recap some of the key points from the recently given King's Speech, which happens roughly once a year in the U.K. at the beginning of a new parliamentary session. And after a general election, this formal procedure basically transforms campaign pledges into, let's say, more detailed legislative programs.

This time around, the King's Speech contained the relatively large number of 40 bills. And it became clear once again that the Labour Party wants to convey that they are both active from day 1 and that they're also keen to ensure that the new government will deliver stability.

That's something that is repeatedly said. And this stability is supposed to be based on predictable, sensible policymaking in the years to come. And that's supposed to happen largely by focusing on measures designed to improve living standards and also the provision of public services.

Among the key topics being stressed over and over again by the Labour Party, remained economic growth and budget responsibility. Something the Conservative Party would usually focus on, but from Labour's point of view has failed to do in the last term.

Let's move on for now to another related core pledge of the new government, namely boosting investment and expanding infrastructure on a large scale. And here, I would single out 2 prominent policies. First of all, Labour plans to eventually nationalize train companies once current contracts run out. And secondly, the announcement of substantial reforms to planning laws that are supposed to facilitate the construction of 1.5 million new homes in the next 5 years.

The former is likely to cause some concern regarding expropriation risks, which I would say are likely to remain quite low overall. And the latter is likely to trigger quite a bit of controversy in Parliament, not only among the opposition, but also within the Labour Party itself as quite a few MPs, especially from the rural constituencies will be critical of building on green land.

Both the envisaged policies on train networks and building permissions indicate that the new government will be much more interventionist than the past few governments. And this is also visible in energy and the transition to a greener economy.

The Labour government has already reversed the previous government's ban on onshore wind farms, and it also wants to create a state-owned investment vehicle named the Great British Energy to boost renewable energy sources across the country. And in addition to that, there will also be a national wealth fund to help decarbonizing industries.

Another focus area is the provision of public services. And in the U.K., a big part of this is universal access to medical services. One of the new government's key pledges in this context is to make the National Health Service more efficient by providing an extra 40,000 appointments each week, which is quite ambitious, and I think it's a target that will be challenging to meet given the high costs involved and the existing staff shortages.

Kristen Hallam

And now let's turn to Raj to talk about how Labour might fund some of these priorities. Raj?

Raj Badiani

The Labour Party, throughout their election campaign, has reiterated every new spending pledge has to be funded, while it continues to adhere to the current fiscal rules. They wanted to establish its fiscal credibility from day 1.

And the current fiscal rule guides a 5-year forecast period. It targets that the underlying public debt situation has to fall as a share of nominal GDP between the fourth and the fifth year of the forecast period, which in this case means between the financial years '27-'28 and '28-'29.

To give you some idea of the scale of the problem, the public sector net debt as a share of GDP, depending on what measure you use, is around 95% of nominal GDP, and that was at the end of June 2024. Another fiscal headwind that the new government has to acknowledge is that the overall tax burden, as a share of nominal GDP, will continue to rise and will reach its highest level since 1948 by '28, '29 financial year.

The Labour government has pledged not to raise any of the main tax items, which include income tax, national insurance, VAT, corporation tax, which obviously limits its options, given its commitment to adhere to the current fiscal rules. It does propose some tax hikes, a very modest GBP 7.3 billion by '28, '29. That's per annum, which amounts to around 0.5% of nominal GDP. These additional taxes will be used to finance higher education and health spending.

The Party also plans to borrow around GBP 3.5 billion a year to finance the setting up of the Great British Energy, to invest in renewables as well as setting up a national wealth fund and to encourage home installation schemes. This is a very cautious tax hike plan, limits its fiscal space and also implies that its commitment to the current spending plans, introduced by the previous government, suggests that many unprotected public services like justice, police and local authorities will actually experience a fall in spending in real terms over the next 5 years.

An interesting warning has actually just come from the International Monetary Fund, which suggests that there is going to be a fiscal shortfall of around GBP 20 billion to GBP 30 billion in terms of the government's need to provide public services. What they described as pressing service delivery and investment needs. So yes, a shortfall of GBP 30 billion.

The numbers at this stage don't really add up. The problem will be that if growth comes in below target, this new government will need to scratch around, either by more severe tax increases. which will obviously break its main electoral pledge or introduce a round of austerity, cutting critical public services, which may cause a lot of internal strife within the Labour Party.

Kristen Hallam

So Raj, speaking of growth, what is our outlook for the U.K.'s economic growth? And does the election outcome have any implications for that outlook?

Raj Badiani

The U.K. economy is now showing some stronger signals that it has turned the corner after enduring a mild recession during the second half of last year. The economy has flatlined since early 2022, so growth has disappointed consistently. But in the first half of this year, growth across the board was actually stronger than expected. We're now seeing persistently strong earnings growth, which is actually intriguing, a very strong growth in all ranges of around 2.5% year-over-year, which is a historical high.

The inflation is now back at 2%, the Bank of England's target. And that's for the first time in almost 3 years. We've also had tax cuts in early 2024. So therefore, our growth projections for both this year and next year and 2025 have been creeping up. We now expect growth at 1% this year, 1.3% in both 2024 and 2025.

Now the Labour government thinks that this is not enough. They're hoping, as Jan touched earlier on, that the series supply side that was formed will boost U.K. productivity and growth. Housebuilding will be at the core of its pro-growth agenda, also greater infrastructure spending. Also, to undertake a green energy revolution to provide a lot of public plants along with private investment to increase renewable energy, et cetera.

This is actually very dependent on quite ambitious growth production. The office of budget responsibility, which is the government's independent forecaster is expecting growth at 1.9% in 2025, 1.9% in 2026. These are quite ambitious. Clearly, when compared to our projection, so 1.3% for next year and 2026. The consensus forecast for those 2 years is around 1.3%.

Again, the Bank of England, again, 1.3% for 2025 and 2026. So clearly, there is a very strong risk that growth will disappoint or will be below the government's projections. If that happens, what does the government do? It has 2 options. If it wants continuous commitment to public services and increase renewable energies, it will either have to, as I said earlier, raise taxes more aggressively or introduce spending cuts to ensure that the public finances remain on a sustainable basis, and they can continue to adhere to the fiscal rules. In the short to medium term, I would expect that U.K. growth will not reach the government's target.

Kristen Hallam

Raj, what can you tell us about the role of exports in the U.K. economy? And what has been the trend with U.K. exports post-Brexit?

Raj Badiani

To be completely frank, it has been a bit of a disaster story. Clearly, we have a trade deal. We have the European Union, which began on the 1st of January 2021. And it provides with 0 tariffs and 0 quotas for all goods, assuming that they comply with appropriate rules of origin.

Despite the trade agreement, clearly, the U.K. has left the EU Single Market and Customs Union, created a wall of nontariff barriers between the U.K. and its biggest export market, the European Union. So if you look at various charts and data coming from the ONS, certainly, UK exports to the European Union have suffered. They are on a downward trajectory.

What is happening is that many smaller- and medium-sized firms are struggling to find the resources or have the logistics capabilities to trade at the European Union, which has actually triggered a steep decline in a number of trading relationships between the U.K. and the European Union, especially after January 2021. So I would say that this is a trend that will continue.

The Labour Party has made it quite clear that it doesn't want to rejoin the EU Customs Union and Single Market, so we're not going to have a return to frictionless trade that we had when we were a member of the European Union. It has promised to take a more conciliatory approach in Brussels and to examine ways of actually improving the current trade deal.

One way would be to make sure that regulations from both sides are lined dynamically or automatically. Another way would be to increase the scope of the trade deal to include some services, which were excluded in the first trade agreement. But as I say, while the U.K. takes its position of not wanting to rejoin the Single Market and the Customs Union, there is not a lot it can do to improve the effectiveness of the trade deal that currently exists.

Kristen Hallam

I do think this is a good time to bring in Chris to talk about trade deals. Chris, what does the new government mean for trade deals? What trade deals is the government prioritizing?

Chris Rogers

The first question is, really, why do you want trade deals? Trade is good, it enriches people, that's all fine. But the whys of it are, firstly, to boost your exports; secondly, to cut inflation by accessing cheaper resources; third, to support industrial policies that you might have; and fourth, to support national security policies that you may have as well.

And I think the U.K. has been notable, if you compare it to the U.S., if you compare it to Europe, generally in the European Union specifically, if you look at Japan and South Korea, in not taking a particularly intentful approach to building out a free trade approach. So yes, post-Brexit, U.K. can negotiate its own trade deals, but it's been very thin gruel so far.

When we look at what the Labour government have talked about, at least within their manifesto, then it's effectively the same cluster of deals that the previous Conservative government were trying to deal with. The biggest one is with India. Very much a lot of green space there in terms of liberalizing trade in both services and in goods. Secondly, joining the Comprehensive Partnership for Trans-Pacific Trade, so CPTPP. That's effectively just really a new trade deal with Malaysia, given that the U.K. already has trade deals with most of the other members.

Raj mentioned the EU. I think the biggest, unanswered question there is really around the Carbon Border Adjustment Mechanism, and that's quite pressing actually for U.K. supply chains. In terms of the U.S. as well, there will need to be some sort of reboot of what was known as The Atlantic Declaration that was signed with President Biden. Clearly, whenever you get a new government, they want to review existing deals.

And there wasn't really anything in the manifesto about other specific deals out there. I think the biggest question in terms of supply chain relationships, really, is how the U.K. wants to work with Mainland China going forward. Particularly given that the EU is applying a range of tariffs, that the U.S. is applying technology restrictions.

Kristen Hallam

So Raj, any thoughts on what Chris has just shared, priorities for the new government on trade deals?

Raj Badiani

I think you'd probably want to hurry up a new trade deal with the U.S. I presume that's something that they've been aiming for, ever since the 1st of January 2021, but it's probably farther than ever, I would suggest, in terms of reaching a trade agreement with the U.S.

Kristen Hallam

And Chris, what is the outlook for getting some of these trade deals done then?

Chris Rogers

Trade deals are always slow and they're always messy. And when you think you've got them done, you don't. And then you go back to your parliament to try and get them approved, and they pick them to pieces. Typically, we're looking at years rather than months to get some of these deals done.

The U.K. is not in a great negotiating position. We're a relatively small economy compared to those that we're negotiating with, and we're focused on many of the industries the people we're trying to deal with also want to grow. For example, the automotive industry. So that's going to be tough.

If we take a look at negotiations in order of ease of delivery, I think the CPTPP, so the Asia trade deal is actually, probably, the easiest because we're effectively, in the U.K., a regulatory taker. So it's a case of you either take the CPTPP terms or you don't. This isn't like potentially looking to get the U.S. or Mainland China or whomever in where they might adjust the terms of the deal. We either join or we don't join.

With regards to the EU, as I mentioned, the main focus is around the Carbon Border Adjustment Mechanism. And actually, the challenge there is the U.K. carbon prices are lower than those in Europe. So actually, right here, right now, if the CBAM payments are starting now, U.K. businesses would have to pay out cash to sell into the EU. So the government may look to try and find some sort of agreement with Europe as to how to handle that.

With the U.S., clearly, we've got an election coming up in November. The outcome of that will drive whether we see a continuation of what we have at the moment, which is effectively bits and pieces here and there around critical minerals, around technology and around shared areas of national security or economic interest. Even if we get a change in government in the U.S., we're more likely to see a transactional approach piece by piece rather than some grand trade deal.

The big win, as I mentioned, would be with India and a full-scale trade deal there. The challenge there is, firstly, it takes a long time to do. Secondly, the Labour government may want to reboot the negotiations. We often see that when we get a change in government, that they want to review the key terms of the trade deal. Passage in the U.K. should be relatively simple if Labour maintains the discipline that Jan was talking about earlier.

In India, it may be more challenging given that Prime Minister Modi now has a coalition to work with. We'll get there eventually, but I think it's going to be quite messy, and we are talking about years rather than months for most of these.

Raj Badiani

Can I just make a very broad statement? I think these trade deals are a lot of noise, ultimately. The loss of GDP by the U.K. exiting at the European Union is going to be around 4%. GDP being 4% lower. These trade deals across the world will nowhere near offset those losses in the medium term. So that's really another downward drag on the U.K.'s ability to grow to around sort of 1.5%, 2% per annum in the medium term.

Chris Rogers

That's absolutely right, Raj. It's always worth keeping these trade deals in context. They can, however, make a transformational difference to specific industries, both for good and ill. Given the reduced scale of the U.K. manufacturing base over the past 20 or 30 years, the government will, I think, be keen to boost what is left as much as it can through these deals.

Kristen Hallam

Pivoting slightly from trade, Chris, I wanted to ask you about the outlook for labor unrest among those involved in the supply chain. Will unions feel newly empowered with this new Labour government?

Chris Rogers

I would certainly expect unions to feel more empowered. Unions have been a big supporter of the Labour Party throughout its history and throughout the various changes that it's been through over the past 5 to 6 years. As we move towards nationalization, for example, on the rail network, which may have an impact for inland trade, that may be a challenge.

I think it is worth bearing in mind, though, that globally, the nature of strikes has changed. Historically, we've seen strikes being very general in nature, so entire unions' worth of people coming out. Whereas what we saw, for example, with the United Auto Workers and we've also seen in Scandinavia this year is a move towards hitting specific targeted areas, whether that's the most profitable plants of a given company or areas that are more politically sensitive.

There is clearly an increased risk of strikes under a Labour government, but we're still in the period of digging out from higher inflation, and a lot of workers didn't necessarily get pay rises that kept track of that, so that may play into it as well. The U.K. has quite lax labor laws compared to most of Europe, has relatively low union membership as well.

The bigger question then, will we see existing union strike is whether we see unions as we've seen in the U.S., try and push to increase their membership into new industries and new companies. So far, there's not been a lot of success. But clearly, with the Labour government there, unions may have more to do than they've done in the past.

Kristen Hallam

Raj, what has been going on with inflation and wages? And what is our outlook there?

Raj Badiani

I mean the first thing to say about inflation -- rather ironically, it was one of the successes in the previous government. Inflation has fallen substantially and was actually returned to the Bank of England's 2% target in both May and June of this year, which was the first time for almost 3 years. And given that it had stood at 11.1% in October 2022, that's quite some fall.

It's still a very fragmented picture. Obviously, goods price inflation has fallen dramatically on a year-on-year basis to reflect tumbling energy prices, but service inflation is still running at around 6%. And clearly, that's critical with service activity accounting for 80% of U.K. GDP.

In terms of the actual forecast for the headline rate, we expect consumer price inflation to average 2.5% in 2024 and 1.9% in 2025, and that compares to 7.3% in 2023 and 9.1% in 2022. So clearly the full inflation has been dramatic, and clearly represents a significant boost to household real incomes, both this year and in 2025 and 2026.

One thing that does continue to concern, not only us, but the Bank of England, is that we have seen very robust earnings growth of around 6% year-on-year and the 3 months to May. Clearly, workers have been demanding compensation for higher-than-expected inflation over the last couple of years.

And also, we're seeing acute labor shortages, especially across many services, which has meant that firms have to offer higher salaries to attract staff and also offer higher salaries to retain staff. So this earnings growth, and particularly true of the services sector, is a significant threat to medium-term price stability.

We seem to be having an evolving wage price spiral in the services sector, which the Bank of England remains particularly concerned about and will not start cutting interest rates until it feels that wage price spiral is beginning to disintegrate. In terms of what we expect the Bank of England to do, we now expect the first interest rate cut to occur this September. That has been pushed back from our previous call of August and before that, June.

And the reason why we're expecting a further delay is because of very strong service inflation, a very strong earnings growth in the sector. There is a strong possibility that first rate cut could be actually pushed back into November. So we could have a situation where we have tight monetary conditions for longer, which could actually undermine the recovery that we've seen in the first half of this year.

The problem is that a lot of U.K. houses are still waiting to experience the full impact of very high interest rates, which the policy rate has been at 5.25%. A lot of households are on fixed mortgage deals, which will be expiring over the next 1 to 2 years. And when they move into new mortgage deals, they would be at considerably higher mortgage rates.

So the Bank of England does want to start cutting interest rates. But again, the inflation outlook and what's happened to earnings probably suggests that they need to continue showing some more caution before they start the listing cycle.

Kristen Hallam

Jan, somewhat related to labor, just thinking about labor supply, is immigration. Will we see any shifts in policy on immigration?

Jan Gerhard

Yes. Immigration and asylum policies are indeed likely to be a clear focus of the new government. And we're already seeing shifts in this regard. Yvette Cooper, the new Home Secretary, has already indicated the more moderate approach to immigration and asylum overall. The Labour Party has also pledged to bring down net migration. For instance, by implementing a reformed points-based legal immigration system.

The Labour Party intends to close what is often called the skills gap to reduce the overreliance on immigrants in certain job markets and the need for related international recruitment. So it will probably be more difficult for businesses and recruitment firms to hire abroad, in particular, when U.K. labor laws are not fulfilled. It is likely that the new government will also apply asylum rules in adherence with international commitments.

Among the key priorities here is the pledge to swiftly decrease asylum application backlogs and improve the housing situation for asylum seekers. The Labour Party has also pledged to strictly enforce the protection of U.K. borders. It remains largely unclear to which degree this will actually lower the currently heightened levels of illegal immigration into the U.K. and how long-term structural reforms will be effectively implemented.

Raj Badiani

Can I just make one final statement? I think this Labour government wants to prove that it can be trusted on the economy and public finances. It boosts its chances of winning a second term. But I would like to end on a gloomier note: The risk to the U.K. economy remains significant. It continues to record very large current account deficits as public finances are in a difficult, troubling state.

And that's a dangerous mix when you continue to see that growth has disappointed basically since the global financial crisis 2008, 2009. This new government needs to tread very carefully. They need to make sure that the markets remain on its side. And it needs to ensure that it doesn't endanger its chance of winning a second term, which I would suggest will probably contain more radical policies should it do so.

Kristen Hallam

Thank you so much Jan, Raj and Chris for taking the time to share your insights with us. Until next time. Thank you for listening to The Decisive Podcast from S&P Global. Please subscribe and join us for next week's episode. Until then, stay curious and stay informed.