Barclays: UK General Election: Snap elections are a net positive for UK assets
Why call an election now?
An early general election now needs a two-thirds parliamentary majority (following the passage of the Fixed Term Parliaments Act). The Conservatives currently have a narrow working majority with 330 MPs (out of 650), followed by Labour with 229 MPs, the SNP with 54 and the Liberal Democrats with 8. But we expect the Scottish National Party and the Labour Party to vote in favour of new general elections, given their publicly stated positions. As a consequence, the general elections are highly likely to proceed on 8 June.
According to most opinion polls (eg, YouGov, ComRes), the Conservatives are likely to significantly improve their existing position in a new election; they have consistently polled around 40% since the start of 2017. But is that enough justification to call for new elections, having triggered Article 50 last month and started the two-year clock on EU exit negotiations? We believe that part of the rationale is that a new, stronger mandate may strengthen the Prime Minister’s hand within her own party, allowing her greater political latitude and reducing the likelihood of a hard Brexit.
It is becoming increasingly apparent that the two-year exit period is likely to prove too little to negotiate a new free trade agreement. A transition period of a few years – where the UK potentially continues to pay into the EU budget, allows freedom of movement, remains subject to the European Court of Justice, etc – is very likely to be needed to allow for a “softer” Brexit, which is less economically disruptive for the UK. With a term of 5 years, the new parliament would also oversee the entire Brexit process (Article 50 initial two years as well as a three year transitional period). But it is also politically contentious. A new, larger Parliamentary majority increases the chances that the Prime Minister gets more wiggle room to make the concessions that might be needed to ultimately get the UK a better deal in the Brexit negotiations. In our view, the odds of that have risen with today’s news.
Will it cost the UK precious time in the negotiating process? And won’t it increase uncertainty?
That might seem to be the case at first glance. In reality, though, we don’t think so. The EU27 is expected to meet on 29 April to adopt the guidelines for Brexit negotiations, followed by a European Council meeting on 22-23 June. Moreover, European chief negotiator Michel Barnier has made it clear that the first six months will be focused not on a new free trade agreement but on issues to do with reciprocal rights of citizens, the UK exit bill, and the Irish border issue (given the constraints of the Good Friday agreement). We do not believe that these snap elections will cost the UK significant time vis-a-vis the negotiations.
It is also possible that the UK elections would reduce domestic uncertainty, if it pushes the various political parties to spell out in more detail what they believe a UK exit from the EU should look like. Uncertainty is unlikely to rise further unless the elections result in a hung Parliament or a change of government, which current polls suggest is very unlikely.
So what are the negatives of this move?
One potential negative is related to Scotland. The SNP is likely to contest this election on a renewed independence platform, and claim the results as a mandate for a new referendum in Scotland. But the SNP already holds 54 seats from Scotland in the UK Parliament, out of a total of 59. The maths suggests that the SNP will have a hard time claiming a bigger mandate than in the last elections. And the Prime Minister has publicly stated that the UK will not agree to a second Scotland independence referendum until after the Scots have had the chance to see how Brexit is working out – in other words, not for several more years.
There is admittedly the chance that the polls are completely wrong and that the election results weaken the Prime Minister’s position within her party and lead to her having less wiggle room. Or that a larger Conservative majority strengthens the hand of those who want the UK to leave after two years, regardless of the economic outcome. Investors will get a sense over the next few weeks of whether Prime Minister May is campaigning on a more or less compromising approach to EU exit negotiations (while she has softened her stance recently, her insistence on controlling immigration and exiting ECJ jurisdiction are structurally incompatible with EU market access). The Conservative Party’s nominations to Parliament as well as the local elections on 4 May could also give hints as to her approach. If the Prime Minister runs on a hard Brexit platform, it would be perceived as negative, while a more balanced stance (in which she pushes back against hardliners within her party) would likely be received well by markets.
Is this a good or bad thing for European assets?
We think good. A softer Brexit is a positive, in our view, for both the UK and the European Union. Given that the UK is one of the largest economies in the EU (and indeed about the size of the smallest 20 EU economies combined), a hard Brexit was always going to be a negative for the EU (though potentially less so than for the UK). A ‘softer’ UK Brexit strategy should in principle mitigate the negative implications for the EU as well.
The French elections remain a key factor. But a scenario appears more likely in which the UK is led by a Prime Minister with wider latitude to negotiate (and make some politically difficult concessions if needed), coupled with pro-EU governments in France (assuming the polls are correct in forecasting an eventual Macron win) and Germany. This should further reduce the angst of a complete implosion of the EU, harboured by some since the Brexit vote and Trump election. Meanwhile, most European risk assets (especially equities) look relatively cheap, we believe the multi-year USD rally is over, and the Euro Area has economic momentum. An acrimonious Brexit would have upset this narrative but the odds of that have now fallen, in our opinion.
What does this decision mean for the GBP, gilt yields, and UK risk assets?
We do not expect the General Election to be the primary driver of gilt yields over the coming weeks, with global sentiment amid geopolitical risks likely to be more important. The short-end should remain anchored, with the BoE unlikely to signal any change in policy stance over a General Election. However, we see this news as a GBP positive. We currently estimate the GBP is about 11% below its long-term fair value on a real effective exchange rate basis. We expect much of this uncertainty discount to be removed over the next few quarters; this should be hastened by an election that reduces political uncertainty and gives the Prime Minister wider latitude to negotiate.
In short, the election itself does not seem to create any additional uncertainty for the UK, and could strengthen PM May’s stance within the Conservative party (she did not become PM by winning a general election, a win now will be seen as a mandate for her leadership, etc.). On balance, we believe today’s decision should therefore be good for UK assets.
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