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Markets woke up to yet another political shock and a night to forget for Theresa May and the Conservative Party.
The outcome of a hung parliament will now result in yet another period of heightened political uncertainty for the UK. The prospect of the Conservatives’ losing their parliamentary majority was a very distant one for Theresa May no more than a month ago, but after an inept election campaign, her credibility is now severely diminished. She has now stated her intention to lead a minority government with the support of the Democratic Unionist Party (DUP), but this may be difficult to sustain, given the tiny effective majority of only 7.
It now seems that this short election campaign was not about Brexit or leadership, but about domestic policies and austerity. A fact Jeremy Corbyn’s Labour Party latched onto with relative success.
The initial market response has been unsurprising. Sterling has taken the brunt of the hit, initially falling around 2% versus the dollar and 1.5% against the euro. This has led to a rise in the stocks of overseas earners of the FTSE 100 and a sell-off in the more UK-centric companies that are more prominent in the FTSE 250 and small cap indices. Housebuilders and domestically-focused banks have fared the worst.
Somewhat ironically, the Conservatives’ strongest performance came in Scotland. Gaining seats from the Scottish Nationalists has all but eliminated the possibility of a Labour-led ‘rainbow’ coalition forming a government. Scottish Conservative leader Ruth Davidson will no doubt have seen her stock within the party rise significantly overnight. But the Conservatives must now renew their government and go on the offensive with a change of direction.
A replay of 1974, when the UK held two general elections in the same year, now looks quite plausible. This could take place as soon as the autumn, but despite Ms May’s intention to continue as Leader and Prime Minister, this is now in question; a decision on Theresa May’s future is likely to rest in the hands of others.
Looking ahead, there are a number of key issues to be addressed. The elephant in the room remains Brexit and the clock is now ticking down on renewed negotiations. Given the loss of the Conservatives’ majority, the Prime Minister will not be able to ignore backbench rebellions either on Brexit or domestic issues. With the strengthened position of UK parties who favour a ‘softer’ form of Brexit, the advantage now appears to be with the EU from a negotiating stance. With official talks due to begin in the next few weeks, the EU is likely to leverage off the political uncertainty that has rapidly shifted from the Eurozone back onto the UK.
Given the increased possibility of a softer form of Brexit, we could actually see sterling begin to rise in the next few weeks but much will depend on how matters progress over the weekend, and the sustainability of the coalition with the DUP.
This will provide little comfort to UK corporations however, and the uncertainty will no doubt have economic consequences. Another lurch down in sterling could well add to inflationary pressures which are already squeezing both corporation margins and disposable incomes in the UK. We are likely to see Purchasing Managers Indices’ and measures of consumer confidence fall going forward. All this reaffirms the Bank of England’s cautious view on the economic outlook for the UK. The Monetary Policy Committee are likely to continue to look through the near-term spike in inflation and keep monetary policy accommodative for the foreseeable future.
The Conservatives are likely to conduct a detailed enquiry into the election, but the indecisive outcome implies a period of heightened political uncertainty in the UK.
In the interim we expect big overseas earners, rather than UK domestic stocks, to continue to garner attention. The FTSE 100, which has significant foreign exposure, is likely to be favoured over domestic focussed smaller caps and the FTSE 250. Sterling is likely to remain weak in the near-term, the next support level looks around the 1.25 level versus the dollar (around another -2% from here). A weaker sterling could mean an increase in market inflation-expectations. Under this scenario, we prefer index-linked over conventional gilts.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
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