UK election throws up new uncertainties for markets

The UK has a hung parliament, with Theresa May’s Conservative Party losing seats and likely ending up 8 short of an overall majority.  It looks as if young people voted in large numbers, mainly for Jeremy Corbyn’s Labour Party.  The Conservatives remain the single largest party however, and together with the Conservative-leaning DUP on 10 seats, they will likely form the new government.  The Prime Minister is holding a press conference at 10am – it is possible that she resigns at that time.  This is an extremely poor result for her personally, having gambled that another General Election would significantly boost her majority.  For an election designed to deliver a “Strong and Stable” government, we face the possibility of a new Conservative Party leadership battle (perhaps beginning later today) and even another General Election later this year.

This renewed uncertainty seems likely to be unhelpful to the UK’s Brexit negotiations, due to start on 19^th June.  The Conservatives did especially badly in “Remain” constituencies.  Perhaps this result therefore partly reflects a rejection of May’s assertion that “no deal is better than a bad deal”, and increases the chances of a softer Brexit (remaining in the Single Market), or even another referendum on the “deal” (which could be the price of Lib Dem political support in the new government, although pre-announcing a second referendum would perversely incentivise the EU to offer a poor deal to the UK in the hope of it being rejected).  Finally, some good news for those fed up with election campaigns: the poor performance of the SNP in Scotland reduces the likelihood of a new Scottish independence referendum in the next few years.

Sterling has weakened overnight, but by only around 2% against the US dollar and euro.  There’s been little bond market impact.  At the margin there may be less austerity and fiscal tightening in future under a weakened Conservative Party, but there will be no significant rise in gilt issuance and the goal of reducing the UK’s debt/GDP over the next few years is likely to remain in place.  Whilst Jeremy Corbyn’s Labour Party did much better than expected, markets don’t need to think about the prospects of nationalisation and significant changes to taxation and spending plans.  The gilt market is not yet open, but is expected to start the day down very, very slightly.  The US Treasury market was little changed in Asian trading – this is not a global risk off event.  Corporate bond markets are a little weaker, with UK banks and insurance companies up to 5 bps wider in spreads.  The iTraxx Main investment grade credit index is 0.5 bps wider.  These are trivial moves.

The momentum of UK economic growth has been fading as we move through 2017.  Retail sales growth, house prices and inflation adjusted incomes are all weakening in what remains a very consumption driven economy.  This election result and the continued uncertainty it brings suggests that this trend continues.  The Bank of England is not going to tighten policy for the foreseeable future – although there is also no likelihood of an “emergency rate cut/QE” of the sort we saw post the Brexit result last June.