‘Stay away from UK assets’ before the election

The Bank of England kicks off the year’s major central banks monetary policy meetings on Thursday, but don’t expect any fireworks.

In fact, if anything the central bank’s policymakers are likely to make dovish comments to try to counter-balance increasing political headwinds.

Even without the Bank of England raising interest rates, the UK economy seems to be starting the year on a more uncertain footing, and a lot of it has to do with the May election.

On May 7, Britons will be called to the polls to elect a new parliament, and the election campaign has grown increasingly threatening for investors and the economy.

The big disrupter is the nationalist extremist UK Independence Party (UKIP), which is known for its anti-immigration and sometimes downright racist rhetoric.

Even before winning the European elections in May last year, UKIP was rising fast in voters’ preferences in opinion polls. This has forced the Conservative government to promise it will organise a referendum on the UK’s membership of the European Union if the Tories win the election.

Prime Minister David Cameron seems to increasingly count on a coalition government with UKIP after May’s vote, despite the party leader Nigel Farage’s racist comments about some ethnic groups.

Cameron has refused to exclude the possibility of an alliance with UKIP after the election and has even promised to bring forward a referendum on the UK’s membership of the European Union if his party wins the election.

The first to raise alarm about what the increased anti-foreigner, anti-EU rhetoric could mean for investing in the UK was deVere Group’s international strategist Tom Elliott, who last year said Cameron was “playing a high-risk game of poker” with the issue of immigration.

At the weekend, a report by lobbying group London First found that increased hostility towards migrants and the EU threatens London’s status as a global business city.

Various investment strategists are growing increasingly uncomfortable with the noise around the election.

“Stay away from UK assets into the 7 May elections,” Societe Generale’s strategists wrote in their recent global asset allocation research.

“We prefer to keep low exposure to UK assets going into the elections next year, as we can expect the Brexit referendum theme to make a come-back.

As the Bank of England continues its difficult communication exercise, the market is pricing in the rate hike cycle less and less. This may support Gilts at the margin but should continue to weigh on sterling versus the US dollar,” the strategists added.

Analysts at German bank Berenberg are more optimistic. They predict that the strong economic recovery in the UK will continue on the back of rising real wages and say the sharp fall in oil prices is a welcome boost for the economy.

UK real wages

UK real wages increasing slightly, just in time for the election. Source: Berenberg

But they too admit that politics is their biggest worry. The rise of UKIP raises the chances of a hung parliament significantly – the Berenberg analysts see a 70% chance of that happening.

“Mild to moderate political uncertainty will not derail the recovery but it may weigh on it, particularly investment. But we need to closely watch this tail risk. We expect the UK to remain in the EU. But there are some ugly possible scenarios. We need to watch those risks carefully,” they warned.

@AntoniaOprita

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