What elections in France and the UK mean for markets

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0:26Pushkin. We've had a serious outbreak of democracy in Europe over the past couple of weeks. First France, then the UK, then France again, and it's been exhausting, quite frankly. But markets seem to be taking it all in their stride, despite success for left and centre parties that investors don't generally like. Today on the show, we're going to ask, is this very silly and complacent? This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at the FT in London, and I'm joined by a man who is no stranger to picking through government spending plans, Chris Giles.

1:09Chris, thanks for joining us on the show again. It's a pleasure, Katie. First off, somehow it's not even a week since the UK election, if you can believe it. Have you recovered? Only just. I was up all night on Thursday night and I was scoring it on a little wool chart I had. You had felt-tip pens all different colours and everything. It pans everything. It was great fun. What was your standout moment of the night? I think the standout moment of the night actually was in the following morning at about seven o 'clock when the former Prime Minister, and often known as a bit of a lettuce, Liz Truss, lost her seat in the biggest swing of all.

1:46Essentially, everyone in that part of Norfolk, which is an East Anglia, ganged up against her and another candidate squeaked through. She looked sort of confused by the whole situation. Yeah, she wasn't expecting it. I don't think any of us were really. But it's not entirely surprising after you blow up the country in 49 days. We will come on to that in a second. So we've got UK and France. Let's start with the UK. We have a new Labour government. We have a new Chancellor, Rachel Reeves. A woman. A first woman. What will these ladies think of next? I don't know. They've been Prime Minister. They've been Chancellor.

2:26Mixed results. But yes, she's the first woman to be Chancellor of the UK in like 800 years that the role has existed. So props to Rachel Reeves. What is she up to so far? She's been actually really rather busy. I mean, it's not been the fireworks when Labour came in in 1997 of giving the Bank of England independence in the first week. But she has done about everything you could do to tear up restrictive planning regimes, which have stopped building of housing, particularly in rather affluent areas and essential infrastructure like onshore wind farms. And there's stuff you can do overnight. You can sort of change planning guidance because that's just written by whatever government's in power.

3:13And they've done that. So they've done about as much on that as they can very quickly. It's only Tuesday. And it's only Tuesday. The election was only on Thursday. And today they've also essentially merged the UK Infrastructure Bank and the British Business Bank to create a national wealth fund, I think they're calling it, which has got former Bank of England Governor Mark Carney seal of approval. But essentially, that's just going to try and lever in by partnering with the private sector to try and encourage private sector investment. I mean, those things already exist. It's not going to be that large.

3:47I say that quietly. But it doesn't mean it's a bad thing at all. Yeah, yeah. Now, the thing is, all of this is sort of quite showy. And it's like, look at us, we can like rip up rules and we can get things done quickly. But over the longer term, something has to give, right? Because in the election campaign, the Labour Party was saying we're not going to put up taxes. There's a little cluster of taxes that we're going to put up, but by and large, we're not going to put up taxes. And we're going to stick to the previous government's promise to keep cutting debt effectively over the next few years.

4:18Have they painted themselves into a bit of a corner here? Because that's the bit that investors care about, isn't it? Yeah. So they have made it clear that they're going to be a responsible government. There's going to be no return to any form of getting rid of the institutions that oversee the economy. So the Bank of England will be independent, will be able to set monetary policy. The Office for Budget Responsibility will do the forecasts. And so the government won't intervene there. And that really does limit what governments can do. So there was a very interesting line in Rachel Rees' speech on Monday, which was to say that she's asked the Treasury to do an assessment of public spending and she's going to bring that to Parliament before it packs up for the summer holidays.

5:07Now, obviously, the Treasury could do that today. I mean, this is something they do all the time. But she needs to look busy and dynamic. So she has done this. They have already done that. They've already given her the results of this. So she knows what it's going to say is that essentially the British public services, the British state is in a bit of a mess. So we're talking like health provision and schools and prisons. A lot of the key services are in a bit of a mess. And the plans that are set out for them, the budgetary plans are almost certainly not adequate to resolve the mess they're in.

5:48So she will take this to Parliament. Now, what we don't know is what she then does with that. Why doesn't she just say, oh, I'm going to do a budget? Because I think she wants to say first, this is the mess I inherited. Right. So there's quite an important thing to say, I've been given a whole mess and it's all terrible and now I've got to do something about it. It's exactly what the Conservatives did essentially in 2010. So they got a first forecast from the newly created Office for Budget Responsibility, which had none of their plans in it. It was just, we've now taken another look at the books and this is where we are.

6:24So I think this is the moment we're going to get. So there's two things she can do with it. She can either say, oh, it's so terrible, we need to spend more and we're going to have to not necessarily rip up our pledge not to raise taxes, but we're going to have to do a bit more of that. and then people will say that they lied in the election campaign and that's going to be quite difficult politically or she'll say something along the lines of and this means it's going to take longer to sort things out you need to be patient and I'm going to spend the next two years blaming the last government for all the difficulties there are in the public services.

6:58I don't know which one of those issues or somewhere in between because it's not an either or. Yeah, yeah. So the last time we had a Chancellor stand up in Parliament and say right, we're going to borrow a ton more money was none other than Kwasi Kwarteng, who was the chancellor under the aforementioned Liz Truss. And that did not go terribly well. Now, actually, that Liz Truss experience where she basically blew up the UK government bond market, investors are constantly saying to me, this was a gift to the world. This was like a lesson that every government, whether it's in the UK or France or anywhere else, can look to and say, we don't ever want to get ourselves into that situation.

7:34We don't ever want to mess with markets that badly because nothing good happens. But so in the event that Rachel Reeves does look through all the books and she looks through all the kind of reports from all the different government departments and says, listen, we're just going to need more money. How does she do that without risking the same sort of thing? I think she does it in a couple of ways. One is you raise taxes. And that's politically really difficult, but will not worry the bond market too much. because so long as you raise taxes in a reasonably broad brush way, generally doesn't have too adverse economic consequences.

8:08Also, they can take some political flack here because they've got a massive majority employment. So that's quite likely. But I think there's a deep issue about trust in politics that if they go back on their entire election campaign, that gets quite difficult. But they can raise taxes. The other thing is that within the rules, the rules, you will be able to fudge them in the margins. So there's going to be an extra year because all these rules are based on the fifth year in the forecast. So now we're in a new financial year, we get an extra year. So that makes things a little bit easier. The Bank of England is almost certainly going to change the way quantitative tightening works.

8:48And don't ask me to explain this. I can, but you really won't want the answer. So this is just the way they offload all of the bonds that they bought to stabilize the system in COVID. Because of some very silly definitions in our debt target, this will help as well. So you can get some billions of pounds and stay within the rules. And so that means there is going to be some more borrowing. But because it's going to be done in a framework where you'll get a stamp from an independent institution that it's OK within the framework. totally not what the NISTRUS quasi-quasing period did. And when you look at the UK's public finances, yeah, they don't look great.

9:26And they really don't look great in the long term. Yeah, worse since the end of the Second World War, according to Reims? Yeah, I think that was maybe not. But worse given how difficult the public services outlook is. So they're not worse than they were in 2010 because they were pretty bad then. But then in 2010, all our public services worked. Now they don't. So in the round, I think it's a reasonable thing to say. But you could see some of the Conservatives who were around in 2010 got very annoyed with that reference. Because on a very strict level, it wasn't true. Because public finances are better now than they were then.

9:59But the outlook for public services, given the plans, are pretty bad. But ultimately, I mean, the way I described it in a recent column is that, you know, if Reeves does want to come to market and say, listen, you know, boys and girls, we do need to issue more debt than we previously imagined. There are ways and ways of issuing debt. You can do it like in a suit with a plan or you can do it in a clown outfit and holding a water pistol. And it's pretty obvious which way is going to upset the markets. Absolutely. And the one thing that this new government in the UK will be is not the clown outfit government.

10:34They're going to be really boring. Yes, as boring as possible. Really boring. And actually what investors are saying to me is like they can't wait for the UK to be boring again. just steady stable politics where you don't have like flip-flopping and like crazy manoeuvres this is something that investors quite like especially when you look across the channel and you see France which we'll come on to in a minute but one thing I did just want to quickly pick your brains on is so the last time Labour came to power in the UK was 1997 historic victory for Tony Blair I was in Moscow at the time so I missed all the fun but that's a whole other story I'm not a spy.

11:12How different is the inheritance effectively for Reeves than what it was for Tony Blair's government? Well, this is an easy comparison because it's terrible. Right. Compared with 97, even though Gordon Brown, who was then the chancellor, the new chancellor, moaned and said, what a terrible inheritance he got from the then conservative government. He had a great inheritance. And that was just nonsense what he was saying. Because the economy was growing fast in the 90s. We had relatively low debt. We had a fiscal rule which was to set the the ceiling of debt to GDP ratio at 40 % of GDP we're now close to 100 basically 100 yeah it's very close to we had incomes and wages were rising fast we had people were generally happy public debt was low house prices weren't huge relative to incomes so it's much harder now and we've got a much and we're really in the teeth of an aging population now, which we weren't in the 90s.

12:09Right, right. So the pressures were less then and the underlying circumstances were better. So it is much harder for the government now. So we should temper our expectations, I think. Right, right. Yeah, it's a tough gig for the country's first female chancellor. It's not easy. Yeah, yeah. So the market's taking that in their stride so far. But if you swim across the English Channel to France, high drama. So a very positive history of what's happened in the past few weeks. There were European Parliament elections. The far right did pretty well. The French president, Emmanuel Macron, called for national parliamentary elections and basically said, I need you to look at your sums again, voters, and not vote for the far right.

12:51So there was a first round of votes for Parliament. And guess who did well? Yes, folks, it's the far right. But they didn't do well enough for a majority. So there was a second round vote and then a kind of ragtag army of lefties, commies, greens, centrists, all sorts, all banded together and cooperated to defeat the far right. And against expectations, it worked. Yeah, very much so. So the far right party in Parliament is third place. So the sort of left popular alliance is in the first place, but that is not one grouping. That is a bunch of different groupings who don't necessarily agree with each other whatsoever.

13:34Then there's the Macron's block in the middle and they came second. And then the far right came third. And there's a smaller, much smaller group of sort of the traditional right in there, fourth. But it means that it's sort of third, third, third sort of territory. But it means that the centrists and the lefties can band together. They can. They all hate each other, of course. Of course. And everyone in France seems to hate Macron himself because they like to decapitate presidents and kings and they see him too much as a little Napoleon. But so, strictly speaking, the leftist bloc, if you like, they've got the largest share of parliamentaries.

14:14So they should get the prime ministership. So all things being equal, they should get the prime ministership. Now, their agenda is looking at cutting the retirement age. They've got zero interest in cutting spending. They've got lots of interest in raising tax on wealthy people. It's the sort of agenda that markets generally do not like at all. And so far what we've seen is there has been a meaningful knock to French government bonds. And the gap between where they trade and where German government bonds trade has like blown out. It's not disastrous, but it's blown out. and investors say it's not super likely to come back in again.

14:50French stocks have taken a knock and it looks like stocks that are very domestically focused are likely to struggle for the foreseeable future, according to some investors at least. I'm not going to ask you to predict French politics because life's too short and it's just far too complicated. But if the leftists are able to push forward their agenda and if the bond market in turn really does not like that and we have un moment listrust, Then what? Because the European Central Bank is very good at shielding small Eurozone nations from disaster in the bomb markets. France, not small. So what can the ECB do?

15:29Well, I think we have to ask the first question is, would they want to do anything at all? And that's like a difficult European question. And the answer to that is, at first, no. Feet to the flames, right? Speak to the flames. The ECB doesn't want to be seen as a rescue mechanism for errant countries. Now, it does have the most powerful tool. It can stop a crisis, just like the Bank of England effectively stopped the Liz Truss crisis and bought time for the pension funds to sort their lives out. Now, the ECB has a tool called the Transmission Protection Instrument. It's got so, it's alphabet soup over there.

16:13The TPI. And this is basically QE for one country within the Eurozone. So essentially, you can create money and buy up French bonds. There are some conditions that come attached to the TPI were it to be used. And the most crucial one is that the country involved would have to be adhering to European Union fiscal rules and not be in the EU's excessive deficit procedure. Naughty step. On the naughty step. And France is just about to be put on the naughty step, even when it thinks it's behaving. so there is no doubt that if you had a very leftist government spending much more France would be put on the EU naughty step and that means the ECB would not be able to use its very powerful tools so yes there are tools available they could stop it but you couldn't have that in conjunction with a government that just wanted to spend like crazy.

17:17No because if it's okay for them. I mean, Greece will be sitting there on, you know, the other side of the Mediterranean, sitting back and saying, well, hang on, because we had to really suck it up to get the money from the EU. So why should you just be dishing it out to France? Yeah. And so it's good that this instrument exists because it didn't exist in 2015 when Greece was at the verge of leaving the eurozone but it does require countries to be behaving so it's really there to stop an unexpected crisis happening in a good well-behaved country because you don't have your own central bank that can do this so the ecb will step in if a market's just take against the country or try and if bond vigilantes try and all gang up on one particularly a small country europe has a defense mechanism which is super powerful.

18:12Yes. Which could kill the bond vigilantes. It's powerful enough. Anyone who tries to go to war with the bond market would be defeated by the ECB. Yes, exactly. But TPI is effectively a rescue package for countries that don't need a rescue package because they're compliant with the fiscal rules. Exactly. Cool. So if you had a country that was not compliant and was deliberately sticking two fingers up at the EU and the ECB, what would happen is a very good question. And the answer is, I think at first, the European authorities would just let that country suffer. Feel the burn. And feel the burn and have a little bit of moment de listros.

18:58And then the only time it would really be a problem would be if that was then spilling over to other countries. and there I think that's when the TPI would come in but it would come in for the other countries, not for France. Oh, the delicious irony. I mean, yeah, Euro crisis 2.0 if we get it and it is very much a tail risk. Yeah, it's a tail. I think it's unlikely. But that would be all sorts of fun from the sidelines. And again, UK would look like this island of stability and come investors to our friendly shores. You might have to wait a bit to get your goods across the channel. but you can invest here and your money's reasonably safe.

19:42It's not a bad sales pitch. Yeah, if you were a betting man, I'm not sure if you are, do you think the French situation will go horribly wrong or do you think they'll find a way to fudge it? No, I think the French situation is much more likely to end up being fudged and kicked into the long grass. And because getting a parliamentary majority will be difficult, it means that external institutions like the EU will be quite important. Those sorts of not necessarily complying with the EU's fiscal rules, but not breaking them by very much, which tends to be the French way. Yeah. I mean, just fun times.

20:21And my final thought on this issue is no more elections. Very bad. They've been bad. It's been quite stressful. Or at least have them quickly. So we don't have to go through weeks and weeks of it. Although we know we've got, I think, 122 days before the US election. Oh, stop. So that's another 122 days of stress and gnashing of teeth, I think. At least. We can all look forward to that. On that sobering note, we'll be back in a second with Long Short.

20:59Alrighty, now it's time for Long Short, that part of the show where we go long, a thing we love, short, a thing we hate. It can be absolutely anything. Chris, what you got? I'm going to go short UK political journalists. Oh, not ours. Not ours. Ours are great and we haven't increased the number of them hugely. but lots of other organisations have and they're going to be struggling because there's not going to be the intrigue and the infighting and they'll have to try and learn some policy which I don't know if they're going to find very easy No So on a slightly similar note I am short opinion polls They overestimated what share of the vote Labour were going to get in the UK and they overestimated how well the hard right would do in France.

21:46Polls are unreliable. That gives me the heebie-jeebies ahead of the US election. Are we going to be able to trust any of the opinion polls? Is it all different out there? I think they're going to be really hard because I think one of the key reasons they're wrong is turnout. So in France, people turned out because of the polls and in the UK people didn't turn out because they thought it was a foregone conclusion. Yeah, yeah. So caution on the polls, boys and girls. That is it for us for now but tune in again on Thursday for more from Unhedged. Unhedged is produced by Jake Harper and edited by Brian Erstad.

22:22Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.