Macro Brief
Talha Khan
- The French legislative elections delivered a hung parliament in July, with the left coalition unexpectedly coming first, followed by the presidential bloc and the far-right National Rally coming third.
- We are likely to see policy gridlock in the period ahead in France, although a hung parliament takes tail-risk scenarios off the table.
- In the U.K., the results came in broadly as expected, although the Labour Party’s large majority reflected more of a Conservative defeat than a Labour victory.
Europe is in the election spotlight again with two of Europe's three largest economies having just concluded parliamentary elections. Both the U.K. and France saw a lower share of seats won by the far-right than expected, with the left or centre-left emerging as the winner. In the U.K., the resounding win for the Labour Party reflected the desire for an end of 14 years of Conservative governments, while in France, the left-wing’s success appeared to reflect a desire to prevent the far-right from entering government.
Europe: Keep an eye on the right
Although the left or left-of-centre has emerged as the winner in both elections, it comes against a backdrop of several European national elections, as well as the EU parliamentary elections that have seen the right wing make significant inroads. Moreover, in both the U.K. and France, the underlying vote share (as opposed to seat composition) also shows ample support for the right or centre-right parties.
We are seeing a period where the median voter leans to the left on economic policy, but to the right on social policy. This suggests more focus on immigration, protectionism, cost of living and social safety nets. It also means a focus on social and cultural issues as much as a focus on fairer economic growth.
Compared to 10 years ago, when it faced the eurozone crisis, the EU is better equipped to handle these difficulties with a robust institutional structure. It also has a lot of experience from coping with one crisis after another in the past decade. But finding agreement in Brussels to maintain the political project is also harder now.
Investment implications
The U.K. result is probably neutral for risk sentiment, while slightly negative for France (easing of tail risks on the positive side but heightened uncertainty on the negative). Domestically oriented equities and bonds could remain weak relative to European assets based in countries with stronger fundamentals, but many French companies are global conglomerates with strong brands and management teams. More broadly, the reaction of other European markets should be muted, because the political situation in France is predominantly a domestic issue.
In addition, whichever shape a policy program eventually takes in France, it will test the EU’s new fiscal rules and a febrile mood across financial markets. In the medium term, French government bond spreads are likely to widen, while the equity risk premium may be higher.
France: political gridlock in the near term
The second round of the French legislative elections suggest a hung parliament:
- The left-wing coalition, New Popular Front, unexpectedly emerged victorious, securing 182 seats.
- The presidential coalition, Ensemble, exceeded expectations, winning 168 seats.
- The far-right National Rally didn’t perform well, securing only 143 seats.
- The centre-right, including Les Républicains, won 60 seats, in line with opinion polls.
The results reflect the specific nature of the two-round French system, wherein the first-round, votes cast reflect who the population wants to win, while in the second round, voting is more strategic, reflecting who the population doesn’t want to govern.
The left and centre came together successfully to stop the far-right, but it will be much harder for the two groups to form a government. Jean-Luc Mélenchon, the leader of the far-left France Unbowed, declared that he would not join such an alliance, but he does not represent the whole left. The left may be ready to split their own alliance to form a government.
We won't know for a while what the next government will look like. This means a policy stalemate for the future, which affects fiscal policy, where it would be hard for any government to agree to the budget cuts that France needs to deliver under EU rules. We can expect bigger deficits and more national debt because of this. On the bright side, the situation prevents more radical policy ideas, fewer major legal changes and perhaps less conflict with the EU.
U.K.: relatively stable political outlook
While Labour won a large majority, the results show that this was more of a Conservative defeat than a Labour Party victory, with Labour having the smallest vote share of any majority government in U.K. electoral history. This likely reflects the population’s desire for a change in government after 14 years of Conservative rule.
The distortions from the first-past-the-post electoral system have been particularly pronounced this election, with Labour benefitting from a split right-wing vote (between Conservatives and Reform) in many Leave-voting constituencies. The Liberal Democrats also benefitted, increasing their seat count considerably, while the Scottish National Party lost many seats, likely consigning the cause of Scottish independence to the next electoral cycle. Reform won four seats, despite taking 14% of the vote across the country, likely prompting future discussions on the electoral system.
Policies we can expect:
Fiscal policy: The challenging economic situation that the new government inherits, as well as the electoral context that led to its formation, means that fiscal policy will probably not see major changes. The U.K. prime minister will aim to demonstrate stability and rebuild policy trust. New Chancellor Rachel Reeves is likely to keep her promise not to raise income tax, corporate tax or value-added tax to support struggling public services; however, she might look at changing the fiscal rules, raising capital gains tax, inheritance tax and reforming council tax in her first budget this October.
EU: The Labour Party has been open about wanting a better trade deal with the European Union but is unequivocal about not wanting to rejoin the single market or the customs union. It is likely that there will be slow, incremental, closer alignment on veterinary standards, labour mobility, professional qualifications, R&D, and defence.
Immigration: Labour has committed to reducing immigration levels, although immigration has accounted for a large part of the U.K.’s growth.
Green energy: Labour has outlined plans to extend the windfall levy on oil and gas until the end of the next parliament.
Overall, the U.K. election results should lessen policy uncertainty and provide a clear and relatively stable outlook in the years ahead.
Tail-risk scenarios refer to either the far-left or far-right winning the election.
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