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UK Election: Uncertainty Piled on Uncertainty 

 

 

6/13/2017 

The election was never going to put an end to the uncertainty facing the UK, given Brexit and the deteriorating economic picture. But the result piles uncertainty on uncertainty.

Key Takeaways

  • The UK election result may augur a more pragmatic approach to Brexit and increase the likelihood of a "soft" Brexit, perhaps even retaining access to the single market.
  • Our high-conviction view is that the Bank of England will put rate rises on hold for the next 2-3 years, or longer. The election reinforces such a view.
  • Speculation about another election puts downward pressure on sterling but economic data is likely to be the key driver.
  • A weak government or coalition probably means that fewer contentious manifesto pledges can be enacted – although there may still be action on utilities.
Initially billed as a tactical shoo-in for the UK Prime Minister, Theresa May's decision to call a snap election turned into a high-stakes gamble. One that failed to come off. Mrs. May called the election with the express aim of securing a stronger mandate – and bigger parliamentary majority – going into the Brexit talks that are due to begin on June 19 .

Instead, her Conservative party was left with insufficient seats to secure an overall majority. The result: a hung parliament.

In other words, a very different picture to the one anyone envisaged when Mrs. May emerged from No.10 Downing Street on April 18 to announce the election.

What went wrong for Mrs. May? She led a disastrous election campaign – compounded by opposition Labour leader Jeremy Corbyn's strong performance on the campaign trail, galvanising his core vote and attracting new, younger voters. He increased his party's share of the vote more than any other Labour leader in any election since 1945.

The Conservatives are likely to lead a relatively weak government through a deal with the Democratic Unionist Party in Northern Ireland.

Mrs. May's position is weakened and she may be replaced as leader of the Conservatives. Her credibility to negotiate Brexit is seriously undermined.

Investment implications


'Hard' vs. 'soft' Brexit, and the future of the wider United Kingdom

The exact Brexit implications are not immediately clear, although the result may augur a more realistic and pragmatic approach. Any deal will now have to be ratified by parliament, rather than simply waived through on a Conservative majority. But the process will be even more complex. The path of the Brexit negotiations will depend on the actions and views of the other 27 EU member states, and the two-year deadline for completing Brexit looks increasingly challenging.

The chances of a soft Brexit may have risen, which should be seen as positive. The dangers of a hard Brexit, with the UK failing to secure a trade deal – and having to rely on World Trade Organization rules instead – have diminished. Many hard Brexiteers preferred this route on day one, but it is fraught with uncertainties for almost all industries.

Elsewhere, the second Scottish independence referendum now seems very unlikely in the short term. The "Conservative and Unionist Party" fought a successful campaign focused solely on preventing a second independence referendum – the so-called IndyRef2. Labour also won back some seats from the SNP.

Sterling should remain fragile, although economic data will be the key driver

The British pound sterling was down more than 2 percent in the immediate aftermath of the vote. Markets had been trading on the dynamic that a larger majority would mean a better negotiating stance for Mrs. May and a softer Brexit. This was perhaps a false assumption, but in any event we now are in a new and unexpected environment.

Any possibility of another election – and uncertainty over who will lead the next government – puts downward pressure on sterling in the short term. Gilt yields are likely to rise somewhat.

Our high-conviction view is that the Bank of England will put rate rises on hold for the next 2-3 years, or longer – especially with gross domestic product growth falling back and household spending slowing as higher inflation bites. The election reinforces such a view, and this is ultimately negative for sterling. But we would need to see economic data continue to soften for sterling to weaken materially again.

Signs of a softer Brexit – and potentially a faster Brexit if the UK were to remain in the single market – would be good news for sterling.

Conservatives will set the agenda, and sector implications will be limited

Domestic stocks will be weak, but perhaps not too soft in the event that the Conservatives continue to lead the government. International earners (i.e., large parts of the FTSE 100) are likely to be stronger.

A weak government or coalition probably means that fewer contentious manifesto pledges can be enacted. Policies would face more parliamentary scrutiny, and this may mean proposals track more closely to the centre ground. And the uptick in voters aged 18 to 24 suggests that the younger generation are intent on making their voices heard in the democratic process.

There will be a risk of economic weakness from higher uncertainty. Higher bond yields may put a constraint on policy and spending, and investment into the UK could suffer from uncertainty –although, again, it will depend on how Brexit negotiations go.

Policy on reforms of corporate governance may take a back seat for a while, especially if May is no longer leader.

Looking at specific sector themes, price caps or other intervention on utilities may also be pushed back. But given that these fairness topics resonate with both main parties, we would expect some policy intervention on utilities.



The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



Allianz Global Investors Distributors LLC, 1633 Broadway, New York, NY 10019-7585, us.allianzgi.com, 1-800-926-4456.

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