Article

UK economic problems in focus as election approaches

May 05, 2010

As we expected, the UK election is still too close to call. A clutch of polls points to no party having overall control. On the balance of seats currently predicted a Lib/Lab coalition government could outvote the Conservatives, or a minority Conservative administration could try to govern for a bit before seeking a clearer mandate through an early second election. None of the polls point to the market preference for a clear majority government.
 
If the polls swing in the last few days in favour of a majority government, more likely to be a Conservative one, as the "Don't Knows" make up their minds, markets will at least temporarily be pleased about that. Whether they do or do not, we should not underestimate the uncertainties that abound even after the election result is known. How will any new government go about tackling the deficit? Will they come up with convincing cuts that they can implement swiftly enough without too much political backlash? Will a new government have first to paint a blacker picture of the UK's position to create the right climate for major changes? If there is a hung Parliament, will all parties continue to play politics, and seek to deny the underlying weak fiscal position, delaying action to sort out the deficit?

During the election all the parties have spoken in general terms about the need to curb the deficit, but none has come up with a costed programme of cuts sufficient to get on top of the trouble or even to deliver their outline figures. Meanwhile Greece has shown what happens to a government which delays for too long. Their problem has been exacerbated by Euro membership, but a non Euro member can also lose the confidence of markets. There is a limit to how far a sovereign economy can use devaluation and money printing to stave off market reality on interest rates and the price of its bonds.

The Greek crisis has shown us that there could be more phases the sovereign debt disaster. That in turn could weaken the banks more, as many of them have rushed into government bonds following the credit crunch. It makes us cautious about western investments, especially European ones. Money is for the moment easy, asset values are rising, and company profits expanding. However, in Europe much of the profit expansion is coming from cost cutting more than from underlying volume growth, whilst weak banks can only sustain so much growth and new lending.

It is time to be a bit more cautious of the West, but to stay invested in the faster growing areas of the world where the easier money is working well.
 

Regards,
Evercore Pan-Asset Team

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