The UK economy will be run on full throttle up to the election. Public spending will be high, money will be loose, interest rates will be kept down. The government will “do what it takes”.
Some of the numbers will improve. We expect the UK economy to start showing signs of recovery, on the back of the earlier and stronger recovery visible in Asia, the Americas and even on the continent.
Some of the numbers will deteriorate. We have sent the first instalment of the inflation rate rise. The Bank of England itself thinks the rate will rise to 2.7% in the first quarter of 2010, with some commentators thinking it might rise even higher. The deficit and accumulated debt figures will also look poor, as last month’s did to the surprise of many analysts.
The Bank of England will want to keep interest rates near zero until the likely date of the Election on May 6th. They will continue with quantitative easing at a slower pace than at the peak of the programme. They will accept any devaluation of the currency that might occur, and will argue that inflation will come back down again in due course.
The markets have been assuming a Conservative election victory to be followed by tougher action to curb the deficit. The latest Mori poll shows a narrower Conservative lead of only 6%, which if delivered in the ballot box would produce a hung Parliament. The main change in the last two months in the Mori figures is a decline in the Lib Dem vote, and a rise in Labour vote. This one poll may not be confirmed by others. Conservative support may rise again. It is, however, a timely reminder of the political risk in the UK alongside the economic and financial risk. There could be an indecisive result in Parliament, which could usher in a period of delaying the major decisions whilst the parties jostle for an opportunity to go for another election. In 1974 a hung Parliament in the February election led to a period of political positioning and continued spending until the minority Labour government in the autumn felt confident enough to call another election.
We are still concerned about the wide range of risks in the UK. The banking sector is still damaged, and very large relative to the size of the economy. The public deficit is too big and growing too quickly.
Money is now flowing into the property sector in Asia and closer at home into high quality well let investments. These are especially attractive to foreigners buying into devalued pounds. We think REIT (Real Estate Investment Trust) ETFs offer reasonable value at current levels, with a yield advantage over general shares.