Well, at least one of “Super Thursday’s” main events turned out to be “Super,” where “Super” means “produced an unexpected outcome that created some measure of market turmoil.”
Basically, Theresa May rolled the dice and lost. I mean, she didn’t actually “lose”, but the idea behind calling the election was to increase the Conservatives’ majority in Parliament in order to solidify a stronger Brexit mandate and instead, she ended up with a hung parliament after her party ended up with fewer seats than before.
With 648 of 650 seats declared by 5 this morning, the Tories had 316 and Labour 261.
“Prime Minister Theresa May had called the election on the assumption that her Conservative Party would emerge stronger, solidifying her negotiating position. Instead, the electorate’s stunning rebuke of her leadership all but guarantees a period of unpredictable political jockeying, intensifying uncertainty about future commercial dealings across the English Channel,” The New York Times wrote this morning, before adding that the result “enhanced the possibility that a chastened government led by Mrs. May, or perhaps an administration led by someone else, would now strike a less confrontational approach with Europe while seeking a way to keep Britain within the bloc’s large single marketplace.”
The pound was crushed early (as in, as soon as the exit polls suggested there might be a “problem”) and generally speaking, things could have been worse overnight as a whole lot of people think cable will likely need to adjust far lower than where it’s trading now:
The Conservative Party lost its parliamentary majority in yesterday’s snap election. On the basis of exit polls and the declared results available at 6:30am (BST), it appears that the Conservative Party won 316 seats in the 650 seat Parliament (losing 15 seats), compared with 265 seats for Labour (a gain of 33 seats).
Given the surprise result – we had expected an increased Conservative majority – the outlook for economic policy settings and the UK’s stance towards Brexit has become more clouded. Our macro forecasts are subject to additional uncertainties. We expect markets now to price a somewhat higher risk premium into UK assets. This has already been borne out in the weakening of Sterling overnight.
Brexit negotiations. Our existing views on Brexit negotiations are summarised here. These were also based on the assumption of a continued Conservative government. Since the referendum result, we have expected the eventual form of Brexit to be closer to a ‘hard’ than ‘soft’ Brexit (i.e., by leaving the Single Market) but with a transitional deal that smoothes the path to that end-point.
We would resist the view that even under a change of government the decision to leave the EU will be reversed or result in a much softer eventual form of Brexit.
The election campaign itself did not suggest any change of heart towards last year’s Brexit vote decision. And the relatively small change in the vote share and number of seats for the Liberal Democrats – the political party that has expressed the most opposition to Brexit – is consistent with that.
A change in government could, however, change some of the priorities in those Brexit negotiations. The Labour Party would likely view some of the Conservative Party’s ‘red lines’ for those negotiations – notably, an exclusion from the role of the European Court of Justice in overseeing any agreements – as being less contentious. That would increase the chances of securing a transitional deal as part of the Brexit negotiations and could moderate the eventual form that Brexit takes after the transitional period has ended.
By comparison, a Conservative government without a parliamentary majority could encounter greater difficulty in making the necessary concessions to the EU-27 that we believe will be necessary to secure a transitional deal that avoids any ‘cliff edge’ in March 2019. At this stage, we are inclined to resist the idea that a reduced Conservative Parliamentary majority will substantially soften the eventual form that Brexit takes.
Whatever you want to say about this, the inescapable conclusion is that voters have rejected May’s approach to Brexit.
Indeed, it kinda seems like people may be rethinking Brexit altogether at this point although it’s possible that the breakup might be made easier in the long-term now that the electorate has seemingly signaled it doesn’t want to see this turn any nastier than it already has.
For his part, Jeremy Corbyn called for May to step down.
“People have said they have quite enough of austerity politics,” he said. “The PM called this election because she wanted a mandate. Well, the mandate she’s got is lost Conservative seats, lost votes, lost support and lost confidence.”
“The prime minister called this election because she wanted to force through an extreme version of Brexit,” Labour’s shadow Brexit secretary Keir Starmer said. “It is clear already that she has failed in that endeavour.”
“The clean Brexit that everyone in UKIP hoped for is now in jeopardy,” said Patrick O’Flynn, who represents the U.K. Independence Party in the European Parliament.
“Could be messy for the United Kingdom in the years ahead,” Carl Bildt, a former Swedish foreign minister, posted on Twitter. “One mess risks following another. Price to be paid for lack of true leadership.”
Yes, “there’s a price to be paid for lack of true leadership.” And as we noted last night, there’s a price to be paid for forcing people to participate in a referendum on something they didn’t really understand in the first place.
Here’s a summary of the global press reaction along with a few more notable quotables via BBC:
Michel Barnier, the EU’s chief negotiator for Brexit, had a more conciliatory message. “#Brexit negotiations should start when UK is ready; timetable and EU positions are clear. Let’s put our minds together on striking a deal,” he said.
Mr Barnier also retweeted European Council President Donald Tusk, who alluded to the March 2019 deadline for Brexit talks.
“We don’t know when Brexit talks start. We know when they must end. Do your best to avoid a “no deal” as result of “no negotiations”, he wrote.
Former Finnish Prime Minister Alexander Stubb and senior German MP Stephan Meyer both said Britain should be given time to form a stable government before Brexit negotiations start.
“It means instability for Britain,” Mr Meyer told German radio. “Officially Theresa May is still the partner in Brexit negotiations, but the political reality is different after this disastrous defeat. I can’t imagine that May will be able to remain prime minister.”
The EU’s foreign policy chief, Federica Mogherini, said it was uncertain when Britain would have a clear Brexit strategy.
“One year after their referendum, we still don’t know the British position in the negotiations on Brexit and it seems difficult to predict when we will, because democracy often requires time,” she observed.
Leaving politicians for the press arena, German tabloid Bild ran the headline “Election blow for Theresa May,” while Frankfurter Allgemeine Zeitung and Die Welt chose “May-Day”.
“The voters of the United Kingdom are insecure, angry and upset,” observed Frankfurter Allgemeine, calling it “a vote against a hard Brexit”.
Elsewhere in Europe, Italian daily La Repubblica declared: “May’s gamble fails, loses her majority”, and noted that voter turnout was the highest for 20 years at 69%.
France’s Le Monde observed that the pound has fallen against the dollar, and that the British economy had already seen the lowest growth of any G7 country during the first quarter of the year.
It added that Mrs May’s party should brace itself for protracted coalition talks, which “may last for weeks”.
Commenting on the Labour Party’s result, Le Figaro praised it as an “impressive rebound”. It also said that, given Jeremy Corbyn’s “spectacular and powerful comeback”, he could now “assert himself as a kingmaker”.
Looking east from London, the Chinese press offered largely factual reports, with little comment except to say the result would have a “huge” impact on Brexit discussions.
In Hong Kong, independent outlets said the Tories had made a “grave miscalculation”.
Shi Zhiqin, a professor from Tsinghua University in Beijing, said China may no longer see the need to keep Britain as a strong ally in the EU.
“But I think Britain’s main concern is to keep China as a trade partner after it lost the EU market,” he told the South China Morning Post.
A correspondent for Qatar-funded Al Jazeera TV, which ran a special segment on the polls, said the Labour Party had led a “fierce campaign that the Conservative Party did not expect”.
The results were covered prominently on some Lebanese newspaper websites, with the front page of left-wing Al Akhbar newspaper reading: “Britain: Corbyn brings down the hopes of the Conservatives.”
In India, newspapers are taking an interest in Preet Gill, who has become the UK’s first Sikh woman MP, and Tanmanjeet Singh Dhesi, the first turban-wearing Sikh winner.
Indian headlines also concluded that the result was a setback for Theresa May, with the Hindustan Times calling it a “stunning blow” for the prime minister.
You get the idea. This was a truly spectacular fuck up for Theresa May and a stinging blow to “Brexiteers” everywhere.
Here’s Citi’s take:
The UK’s early General Election has sprung a major surprise for observers and investors – and for Prime Minister Theresa May, who called the election expecting to consolidate her majority. Instead, according to the BBC projection at 5am, the Conservatives lost 12 seats to 318, 8 short of a majority. Labour gets 262 seats (up 33 seats), the SNP 35 seats (down 19), the Liberal Democrats 13 (up 4), Plaid Cymru 3 (unchanged) and Green Party 1 (unchanged). The remaining seats go to Northern Ireland Parties. Projections by Sky News and ITV also point to a hung Parliament. Turn-out increased by 5pp compared to 2015.
Conservative minority government, no Theresa May?
A period of political uncertainty lies ahead. As a default, Theresa May would stay as PM and the Conservatives attempt to form a government, possibly supported by Northern Ireland’s Unionist parties. However, following what is widely regarded as a poor campaign and failure to translate a strong lead in the polls into a larger majority in the Commons, we expect May is likely to resign. That would trigger a Conservative leadership contest. MPs would first whittle down a list of candidates down to two, followed by a grassroots poll in which Brexit-leaning candidates would have good chances. The process could take 2 months, during which May would remain PM. It is an open question whether she could launch the Great Repeal Bill with the Queen’s Speech on 19 June and begin the negotiations with the EU, also on 19 June, in the meantime. A new Conservative leader may also choose to hold fresh elections to secure a fresh mandate.
Brexit risks rising, both ways
The biggest casualty of the election, and the focus point for investors, is the UK’s Brexit strategy. If the negotiations kick off as planned, the contentious issue of the financial settlement (up to €100bn “Brexit Bill”) could swiftly lead to tensions and reveal whether the anti-EU Tory wing or the pro-EU wing with opposition support would hold more sway over the negotiation team. If May resigns, the negotiations could be delayed by months due to the leadership contest, potentially new elections and even another process to design the UK’s negotiation strategy. 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 our base case. The UK’s decision to leave the EU is irreversible under Article 50 (although the ECJ 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.
There is upside
Labour leader Jeremy Corbyn will be strengthened by the result, but as his party will not be in government, his plans to nationalize key industries, raise taxes and spending and tighten labour laws will not be implemented, avoiding economic uncertainty. In addition, the weak result for the SNP in Scotland further undermines the momentum for another independence vote, in our view.
And here’s Deutsche Bank:
The Conservatives’ election campaigned was centred upon increasing PM May’s majority in order to improve her ability to achieve her vision of a harder Brexit. At the same time, the opposition campaigns (Labour in particular) focused to a large extent on the domestic economy and a perceived backlash against austerity measures and tight fiscal policy. As a result, the narrative of the election result, and the extent to which it is seen as a push back against both (a) harder Brexit and (b) austerity will also represent a key driver of longer term price action. We would expect the initial price action to be focused on the impact of sharply increased political uncertainty. However, looking further out there is the potential for the vote to lead to a softening in the Brexit stance given the electorate’s rejection of the Conservatives’ policy together with increased push back against increased fiscal tightening. These drivers would be more bearish rates, but in the short term at least the market is likely to focus first on pricing increased political uncertainty as the market digests the formation of the new government together with the potential for new Conservative leadership. This suggests bullish rates price action should dominate initially.
And then SocGen’s Kit Juckes on the pound:
At the time of writing the BBC projects the Conservatives will end up with 318 of 650- seats, 8 shy of a majority but enough to form a minority government, and 12 down on the total when Prime Minister May decided to call the vote. A political disaster for the Prime Minister and for the Conservatives, that leaves a weakened Government as they enter negotiations with the EU about the terms of leaving the EU.
Sterling is supported by valuation – it has now bounced off 73, some 4% below current levels, three times since 1992 – in February 1993, December 2008 and October 2016. We will probably test that level again this summer. That is likely to take GBP/USD to 1.25 but not to 1.20 and EUR/GBP above 0.90 but things have to get even worse before we can ponder levels above 0.95.
Soft/hard Brexit is a red herring. In the near-term, the debate will be about whether a minority Government is forced to take a less combative approach and negotiate a ‘softer’ Brexit. We don’t really understand how that can happen. A soft Brexit involves negotiating something akin to remaining in the Single market. The EU position is crystal clear: that requires accepting free movement of people, which is surely unpalatable even to a minority Conservative government. On that basis, any short-covering based on talk of a ‘soft Brexit’ seems doomed to be temporary.
In the longer run, what drives the pound will be relative economic performance and policy. A minority government can’t do the kind of damage to the economy a misguided one could do, but as growth slows, the MPC will remain on hold and as others raise rates. The contrast between MPC and Fed or ECB may not be stark enough to trigger a sterling collapse from here, but will anchor it around these long-term historical lows.
The FTSE did manage to rise on the back of the weaker pound, but needless to say, this introduces all sorts of uncertainty for UK assets.
Finally, in case you needed some more analyst chatter, here’s a quick rundown of opinions from Bloomberg…
NICK BROOKS, head of economic and investment research at Intermediate Capital Group, said by phone:
- “One could argue that at least some of the votes indicate that the U.K. population would like to see a softer rather than harder Brexit. This may to some degree lead to a more conciliatory approach with the EU. But it’s all in play because we also know there’s a number of backbenchers in the Tory party that’s very pro-hard Brexit.”
- Says “real” possibility of higher taxes, given Labour’s substantial gains. “Their policy platform can’t be ignored.”
STEPHEN MACKLOW-SMITH, portfolio manager at JPMorgan Asset Management in London, said in interview:
- “It’s very dangerous to look at the U.K. stock market through the prism of the domestic economy.”
- Besides the “almost automatic repositioning” within U.K. stocks when sterling weakens, “investors also react to overseas events. More important here is the first year of synchronized global growth in ages. We don’t need to re-position dramatically now.”
DAVID JANE, fund manager at MITON GROUP, wrote in a note:
- U.K. now appears even less compelling vs other opportunities, as indecisive election outcome and subsequent sterling slump mean outlook is even more unclear
- Maintains low overall exposure, but sees some opportunities in consumer services, favors pub and restaurant groups
- In homebuilders, background for volume remains favorable
UBS global macro strategists including JOHN WRAITH said in a note:
- Watch the GBP readacross to U.K. equities as initial shock wears off; beta of FTSE 100 to currency is close to the most negative in a decade
- Suggests a 10% drop in sterling could mean a 6% gain for equities
- Impact of domestic politics on U.K. equity markets primarily through currency; notes FTSE 100 underperformance in USD terms vs locally since Brexit
- Prefers internationally exposed stocks over domestics as sterling may weaken more in the near term and economy likely to slow further
- Also prefers Europe equities to U.K., given stronger macro backdrop, earnings momentum and “fading” political risk
BLACKROCK INVESTMENT INSTITUTE strategists and portfolio teams said in a note
- Result is mild short-term negative for U.K. domestic assets due to uncertainty and prospect of weak government
- Sees bigger risks of an economically disruptive “no deal” Brexit if minority government is hostage to euro-skeptics, but also sees wide range of potential outcomes including softer Brexit in light of new makeup of parliament
- Pound remains good barometer of Brexit risks
- Expect BOE to keep accommodative policies in place to support economy, looking beyond short-term inflation spikes unless price pressures “become sticky”