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UK Election Ends in Hung Parliament

9 June 2017PoliticsUK
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The 2017 UK General Election has not delivered the expected majority for the Conservatives leading to a weaker British pound (GBP) amid a rising risk of a disorderly Brexit.

Winning 315 seats out of 646 declared, the UK's ruling Conservative Party remains the largest party in parliament but has fallen just short of a parliamentary majority. The party needed to win at least 326 to secure an overall majority.

The implications of these unexpected outcomes are increased uncertainty over the leadership of the UK and heightened volatility when Brexit negotiations are about to begins soon. The outcome leaves the UK in an even weaker negotiating position when it comes to Brexit negotiations which are due to start on June 19.

As of writing, GBP has dropped around 2.1% against the US dollar. But global equity markets have so far been unharmed by the vote, with the Nikkei up 0.5%, UK equity futures down -0.2%, and US equity futures up 0.1%.

Political and Economic implications

Heightened Political uncertainty ahead: Citi analysts see a high probability that Theresa May resigns triggering a leadership contest.

Brexit risks: The hung Parliament makes both a "soft" Brexit (staying in the Single Market) and a chaotic Brexit (no deal) more likely than before, potentially even a second referendum, although "hard-but-smooth" Brexit would remain Citi analysts base case. The UK's decision to leave the EU is irreversible under Article 50 (although the European Court of Justice may have to rule on this). Extending the Article 50 process requires a unanimous vote of EU countries, but EU countries may not want the resource-intensive process to drag on for longer.

Negative for UK economy: The election has had a negative impact on the UK economy, as seen from the sharp fall in the UK Services Purchasing Managers' Index (PMI) to 53.8, the lowest since February. Confidence declined, as companies delayed decision making ahead of the Election. With the private sector accounting for 55% of the economy, this reduces the likelihood of a sharp rebound in the economy in the second quarter. Citi analysts expect GDP growth to fall to 1.7% in 2017 and 1.5% in 2018. They do not expect the Bank of England to hike rates before 2019.

Market implications

GBP: Although Citi analysts believe the GBP looks to have already priced in much of "hard Brexit" risk before the elections, it may continue to experience volatility. A higher risk of a "hard" Brexit would likely mean GBP/USD trades lower in the near to medium term and back towards the lows of 1.20. Under this scenario, Citi analysts think GBP upside remains capped as confidence remains soft till at least the end of the Article 50 EU negotiations.

Bonds: The market would likely reduce the probability of a smooth Brexit on the basis that Eurosceptic's may have more influence. Citi analysts see modest upside risk for gilt yields.

Equities: While Citi analysts see modest downside risk for UK shares following a 40%+ rise from 2016 lows, weakness in GBP is likely to offset negative impacts to stocks with significant international exposure. Citi analysts' mid-2018 forecast for the FTSE 100 stands at 8,000 and they maintain a neutral allocation to UK equities within a diversified portfolio.

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