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FDs face post-election dichotomy of support for economic agenda and fears over UK solidity

THE first few minutes after the financial markets opened on the morning of Friday 8 May told the story about the reaction in the City to the tightest general election in recent memory.

Shares in estate agents and housebuilders jumped as fears of a mansion tax faded, around £1bn was added to the value of Centrica as an energy price freeze fell off the agenda. Meanwhile shareholders in rail companies and outsourcers cheered the fact that the private sector would remain key to public service delivery.

But away from special interests, it was less clear what the reaction of the business community was to the outright Conservative victory. The British Chambers of Commerce (BCC), which represents both large and small companies, called for “growth, not austerity” and recommended tax incentives to encourage investment.

But at the same time the BCC, and the CBI, which represents larger employers, threw weight behind the UK remaining as part of a reformed European Union and warned of the danger of a “Brexit” if David Cameron lost the in/out referendum he plans to hold in 2017.

This dichotomy between support for the economic agenda but concern over the outlook for the UK in Europe – and indeed the solidity of the UK itself – is shared by private sector economists.

“After the initial euphoria generated by the shock result has dissipated, the markets may start to worry about the potential impact of Brexit on the UK economy,” suggests Brian Hilliard, UK economist at Société Générale.

On the domestic front the overriding feeling will be relief that the election delivered a single party government with no need for the forecast weeks of negotiation between several parties to put together a coalition.

“There will be relief that there will be stability as there were so many concerns before abut how unstable the government might be, says Vicky Pryce, former joint head of the UK’s Government Economic Service and now economic adviser to the CEBR.

Howard Archer, chief UK economist for IHS Global Insight adds there was “clear evidence” that economic activity had been hampered by increased business caution due to the uncertainty in the run-up to the general election. “Businesses will likely be pleased overall with the result given that the Conservatives are seen as more business friendly than the other parties,” he says.

Tax promises 

According to Pryce, the prospects of lower taxes will please finance directors who will welcome the manifesto pledge to cut corporation tax and to freeze income tax and VAT.

Ironically tax issues will make an unexpected return to the agenda as the Conservatives promised – perhaps when they expected to be in a coalition and thus not to have deliver their manifesto in full – to find £5bn from tax avoidance.

They have also made a series of unfunded commitments to cut taxes, not least the pledge to raise the personal allowance for income tax from £10,600 to £12,500 and the higher rate threshold from £42,385 to £50,000 by the end of the parliament, at an estimated cost of about £7bn.

As Samuel Tombs, an UK analyst at Capital Economics points out, tax rises seem likely to feature in the Tories’ first Budget on 8 July. Since they have ruled out hikes in the main rates of income tax, national insurance and VAT, the Treasury’s sights could focus on duties which could hit brewers, cigarette makers and the motoring industry. Another option might simply be to allow the fiscal targets to lapse, as the coalition essentially did when austerity measures pushed the economy into stagnation, wiping out the growth it inherited.

“While a clear Tory election victory has on the face of it made the fiscal outlook clearer, there remain big question marks over whether they can achieve their ambitious targets,” says Tombs.

Pryce suggests that while business will welcome lower tax they will be concerned about where the £30bn of spending cuts will fall as part of the austerity programme. They will be listening carefully to what new business secretary Sajid Javid has to say on wider issues of policy.

“They love reductions in bureaucracy but they would not want industrial policy thrown out of the window. They will be concerned about the science budget and about skills in terms of their recruitment,” she says.

She added that small firms in particular that tended to have less access to the capital markets would be keen to know what the Government is now planning to do to boost lending to business.

But if ministers do deliver on their manifesto there are several initiatives that should make FDs happy. Key points in its business manifesto included plans to cut red tape by £10bn in the next parliament, treble the number of start-up loans and help businesses to expand from small to medium-size through the Help to Grow initiative.

Part of the unions?

On the external front, the big picture issues still trouble companies, particularly over Britain’s relationship with the European Union, its main trading partner, and its very future as a UK.

The prospects of a referendum on the UK’s membership of its largest single trading block and a poll by Scots to break up the UK makes business planning hard. “It certainly doesn’t remove all of the political uncertainty,” says Neil Woodford, manager of Hargreaves Lansdown’s CF Woodford Equity Income Fund.

With a smaller majority of just 12, the majority eurosceptic elements of the Conservative party could hold more sway over the timing of the referendum and negotiating strategy employed than under a coalition.

“Although this is far enough down the line to not worry markets at this point, much like the Scottish independence referendum of September 2014, this could become a major market issue as we approach the poll,” said Victoria Clarke, an economist at Investec.

These are likely to be more significant for finance directors of large companies with cross border interests – whether that border is the English Channel or Hadrian’s Wall. One company in the latter camp is Standard Life, the Edinburgh-based pensions and insurance giant, which warned at its May AGM that the firm would consider leaving Scotland in the event of a vote for independence.

Chairman Sir Gerry Grimstone told shareholders it had put in place “precautionary measures” to tackle any issues arising out of it. “We [will] look at the facts and if we had to say something to ensure continuity to customers and shareholders we would do it without hesitation.”

According to Woodford, that the performance of the SNP has given them “a significant voice in parliament but no power”.

“Question marks remain, therefore, about the viability of our constitution and the Union,” he says.

When it comes to leaving the EU, two German research institutes found that Brexit could cost the UK as much as £215bn, or 14% of GDP, or as much as twice the loss resulting from the global financial crisis. Europe is the UK’s largest trading partner and the fear is that if the UK left the EU it would leave the single market that allows free movement of products, capital and labour across its members’ borders.

“This would be a major blow,” says Graham Bishop, an ex-City economist and founder of GrahamBishop.com, a network that tracks European integration.

“How will we disengage?” he asks. “The scale of the renegotiation to be done not just with the EU but all the trade agreements that the EU has with 80 countries such as the US means we would have to renegotiate all and that’s not a small task. The others will not want this to be painless process for the UK.”

Mark Carney, the governor of the Bank of England, said in May that he was aware from his discussions with directors that they have an “awareness of some of this political uncertainty”.

While he said the statistics suggested that so far businesses had “not yet acted on that uncertainty” and were continuing to hire and invest, he said the issue should be resolved as soon as possible.

According to Bishop, there is no question the rest of Europe wants the UK to leave but he adds: “They are not going to try and keep us in if the price is breaking up the single market. That was Mrs Thatcher’s greatest triumph in Europe. So there is the potential for an utter irony for this government.”

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