Head - EMEA Investment Strategy
June 9, 2017
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The UK’s Brexit negotiating position looks weaker after the surprise election result
UK Prime Minister Theresa May called a snap general election in order to try to win a bigger majority than the Conservative majority of 17 MPs that she inherited. The main reason she did this was to capitalise on the polls in order to give her a stronger hand in her Brexit negotiations with the EU, as well as to ensure eventual parliamentary approval for the Brexit deal. The Conservatives started the election campaign with a lead approaching 20 percentage points in the polls, but this was reduced to a lead of just two points in the latest poll just before the vote yesterday.
The first exit poll – showing that the Conservatives would win the vote but not have an overall majority – proved to be correct. With around 99% of votes counted, the results are as follows: Conservatives 318 (down 12) with 48.9% of the overall vote, Labour 261 (up 31) with 40% of the overall vote, Lib Dems 12, UKIP 0, SNP 35, other 22. There will be a hung parliament as no party won an outright majority of at least 326 seats.
Britain will now have only its third hung parliament since the Second World War, but the second in the last seven years. There is likely to be a period of uncertainty while a new government is formed. Sterling has been correlating closely with PM May polling in the last few weeks, and after this exit poll has immediately fallen by 1.6% to $1.2750.
Early signs are that the electorate focused more on domestic issues than Brexit in their voting patterns. The Conservative manifesto attracted criticism as a result of, and saw their slide in the opinion polls begin with, their education policy as well as their policy of making the elderly pay more for their healthcare, which was later withdrawn.
In addition, PM May was criticised during the campaign for having cut policing in the UK during her prior tenure as Home Secretary, not helped by the two terrorist atrocities during this election campaign. They lost ground in the south and didn't make headway in Labour heartland areas. Labour leader Jeremy Corbyn’s campaign slogan of 'honest politics, straight talking' gained increasing traction with voters during the campaign. With the high turnout of 68.7% (with a higher than normal level of young voters), and the sharp falls in the votes for both UKIP and the SNP, Britain is returning to two-party politics. It was notable that where turnout was highest, Labour made its biggest gains.
PM May has the first opportunity to try to form a coalition government, and is currently in discussions with the Queen to get approval to form a government. However the Liberal Democrats, who supported the Conservatives in 2010, uniting in the need for austerity after the global financial crisis, are not expected to be supportive now. The more likely Conservative coalition partner could be the Democratic Unionist Party (DUP) who won 10 seats with 1.5% of the vote. The DUP are the largest unionist party for Northern Ireland, the largest party in the Northern Ireland Assembly, and are the fifth largest party in the UK House of Commons. They are likely to drive a hard bargain for their support, potentially including: a seamless border with the Republic of Ireland, no means-testing for fuel payments, and maintaining the "triple lock" in state pensions.
If PM May cannot form a coalition, then Corbyn will attempt to do so, despite saying on the campaign trail that he would not be keen to form a coalition with both the SNP and LibDems. The talks between party leaders and their negotiating teams are expected to take up to five days. The new leader's coalition needs to be formed before the 13 June when the new parliament is due to meet for the first time, and approved in the queen's speech on 19 June.
If no coalition is possible, there is precedent for a minority government to rule, however these have tended to be unstable and short-lived. The Fixed Term Parliament Act gives two avenues for another election to be called: a two-thirds majority of MPs calling for a new election, or a no confidence vote.
Four matters are clear in all this. The first is that the UK’s negotiating position with the EU will be more challenging than it already was. Both the DUP and the Labour Party may push for a softer Brexit, and there needs to be agreement on any shift in the UK negotiating stance ahead of the start of the EU talks on 19 June.
Secondly, PM May will certainty have been weakened and both her authority and judgment questioned, given that the Conservatives won less seats than when she called for the snap election. She has said today that she won't resign. If she does at a later date then there will be another Conservative leadership contest.
Thirdly, the UK's cyclical slowdown is likely to continue and possibly accelerate with the uncertainty posed by both uncertain domestic politics and by the tougher Brexit negotiation.
Fourthly, with the Scottish National Party losing 21 of their 56 seats, there is likely to be less pressure for or another Scottish referendum to leave the UK.
In conclusion, there are now two quite different UK political risks to assess. Firstly, how and how quickly a stable government is formed. This is not straightforward - as former Liberal Democrat leader Nick Clegg said today, after losing his seat, the UK is "a deeply divided and polarised nation".
Secondly, the Brexit negotiating stance is now in doubt. In market terms, the main impact of this could result in higher volatility for UK assets in the weeks ahead. With the probable uncertainty ahead, Sterling could fall to $1.25 against the US dollar according to our FX team. This could support large-cap companies with overseas earnings, and in addition many of those have dividend yields over 3%, so the downside for the FTSE 100 could be limited.
Gilts are likely to initially benefit as a safe haven with ten year yields falling below 1%. Thereafter gilts are likely to range-trade, with the upcoming supply not currently a problem given the government’s overfunded position, however possibly threatened by the potential EU exit bill.
The Citi Private Bank Global Investment Committee is neutrally weighted in UK large-cap equities and underweight in mid and small cap equities.