Our Opinion: 2017

Here we go again

Theresa May has performed an about-turn. She has announced her intention to hold a general election on June 8.

Up to now, the prime minister insisted that the current parliament will run until 2020, but a desire to strengthen her hand ahead of the Brexit negotiations, as well as the presumptive hope of capitalizing on a very favourable lead in the opinion polls, has led to a change of heart. Parliament will still have to vote to hold the early election, but as the leaders of the major opposition parties have already announced their support it is likely to take place.

Opinion polls suggest that the Conservative government will return to office with a healthy majority, although much can change during an election campaign. While Brexit will be the defining issue of this election, what type of Brexit voters opt for could complicate the outcome.

The election is likely to have a limited economic impact. Slowing growth in real incomes is already underway and will likely drag economic growth down this year relative to last. The economic effects of Brexit will likely only be felt over the long term; this election may give us a better idea of the direction the negotiations will take and the economic consequences that may ensue. The pound is likely to continue today’s strong recovery to close some of its discount to other major currencies.

As markets grapple with the news that they have to add another election to this year’s already busy calendar, theories about May’s motives are sprouting fast. Given the wide lead the Conservatives enjoy in the opinion polls, her timing looks astute. However, her call for the vote is likely to have more to do with the forthcoming Brexit negotiations. Indeed, during her speech the PM made clear that the thorny issue of Brexit still divides parliament, making it difficult for her to deliver her preferred deal given the slim majority of the current government.

In addition, the vote means that the next general election need not take place until 2022, which could give the government the necessary scope to negotiate a lengthier transition deal after the UK formally leaves the EU in 2019. A further consideration is that if the PM’s gamble pays off and she is returned to office in a stronger position, her negotiating stance with the EU, which may have looked to use her slim majority at home as a source of leverage, could strengthen.

May’s plan, if it proceeds as she intends, could support the UK’s economic outlook. It is unlikely to ward off the headwinds that falling real incomes and sliding business confidence will have on growth in the short term, yet it does reinforce the view that the economy will stage a medium-term recovery.

A fresh UK election is unlikely to delay the Brexit process materially and European Council President, Donald Tusk, has already suggested that he does not see the UK election altering the EU27 plans.

The initial headlines on a statement from Number 10 Downing Street prompted a drop in the pound, but the fall was short lived. The currency became the standout G10 performer when the early election was confirmed, suggesting that markets do not see this latest development in a negative light. If the result conforms with current polling trends, it could remove a source of long-term uncertainty.

Sterling is on course to recover some of the losses it suffered after June of last year as the economy finds its footing. More importantly, barring a major electoral shock, today’s news is immaterial to the Bank of England’s policy outlook. Similarly, gilt markets are largely flat on the news, which is expected to have little bearing on the fiscal and monetary outlook.

Equity markets across Europe were already trading on a soft note before the announcement. While UK markets fell further on the news, the drop is largely attributable to currency strength. Given the large overseas exposure of the FTSE, the index’s performance will remain vulnerable to currency swings.

The FTSE 100 saw its biggest one-day drop since the Brexit vote as the pound surged to a six-month high following the snap election announcement.

The index saw more than £45bn wiped off as it fell 2.4% to end the day at 7,147.5 points, marking its biggest one-day percentage fall since 24 June last year, when it lost 3.1%.

Our strategic partner, UBS, retains its six-month forecast of 7550 for the UK FTSE-100, 5.6% higher than current levels. If May’s gamble pays off, it could strengthen her hand, smooth the process of leaving the EU and help Sterling stage a modest recovery over the next 12 months.

18th April 2017