The U.K. Labour Party won a landslide victory in Thursday’s election. But the new government will soon run into stark fiscal reality, leading to unsettled financial markets in the months ahead, finds a report by National Bank Financial Inc. (NBF).
“On the one hand, it has presented an ambitious agenda to improve public services and advance the transition to green energy, all the while promising no major tax increases for the middle class and no return to austerity,” the report said, noting that the party also promised not to raise taxes. “On the other hand, this agenda will inevitably collide with the U.K.’s historically high debt and interest costs.”
NBF noted that public sector net debt is currently 98% of GDP this year, up from 35% in 1996, and that annual interest costs on this debt is currently £60 billion.
The Labour Party pledged to decarbonize the electricity sector by 2030 (estimated to cost £116 billion), ramp up defence spending, reduce hospital wait times, recruit 6,500 new teachers, spend an additional £23.7 billion on green programs and build 1.5 million homes over the next five years.
“The era of borrowing without worrying about the cost of interest payments is over,” the report said. “If the Labour Party attempts to fully implement the costliest parts of its agenda, expect volatile U.K. financial markets in the coming months.”
Labour said it’s planning to fund its agenda by cutting certain tax breaks, closing loopholes, curbing tax shelter arrangements, increasing borrowing and raising more revenue from private equity firms.
“It also plans to crack down on tax avoidance and increase taxes on oil and gas companies,” NBF said.
The new government is hoping its green energy projects will spark enough economic growth to boost its revenues. However, that hope is highly optimistic, with GDP growth forecast at just 0.5% this year, and 0.75% next year, NBF noted.
“Without a surprise surge in economic growth, Labour may eventually have to backtrack on some policy goals and raise taxes on the middle class and businesses, angering voters across the political spectrum,” the report said.
Additionally, the new government’s big majority could increase internal pressure to ramp up spending even more than promised, NBF warned.
Ultimately, Labour will “have to choose who to disappoint: its supporters or the financial markets,” the report concluded.