UK Election Result Compounds Brexit Uncertainty - Context

Britain’s election has produced a messy result, with no party securing an outright majority. The hung parliament adds further uncertainty to Brexit talks with the European Union(EU), though it probably won’t affect the UK’s short-term economic outlook.

British prime minister Theresa May’s election gamble has spectacularly backfired. With almost all seats counted early Friday morning, her Conservative Party will remain the biggest party in the new parliament with an estimated 318 seats. However, the Tories have fallen a few seats short of an absolute majority (326 seats). Jeremy Corbyn has led the Labour Party to surprising gains with 261 seats and 40% of the popular vote.

As things stand, May would remain prime minister. Hours after the results were in, May said that she would aim to form a minority government, relying on support from the Democratic Unionist Party (Northern Irish unionist party, 10 seats). It’s anybody’s guess how long such a government would last, and a second election should certainly not be ruled out.

Mixed Market Reaction

There was a mixed reaction to the result in UK financial markets. The pound bore the brunt of the uncertainty, with sterling weakening more than 2% to new lows versus the US dollar. In equity markets, the FTSE 100 Index of larger-cap UK stocks was up during midmorning trading, though the FTSE 250 Index, which includes more domestic-oriented stocks, was down. Government bond yields were also mixed.

Financial markets had been wary of the possibility of a coalition led by the Labour Party, which has shifted well to the left. This outcome has been avoided, at least for the time being. But, at a time when the UK political outlook is already clouded by upcoming Brexit negotiations, it has just become even more uncertain.

A Softer Brexit?

Despite the uncertainty, it is possible to put a positive spin on the election outcome. The election was called to give May a mandate to pursue her vision of a hard Brexit (though she herself was a “remain” supporter). That vision was rejected last night, putting a softer Brexit, in which the UK maintains some links with the EU in exchange for compromises on various issues, back on the table. It’s even possible that a second Brexit referendum could be called.

But that route looks perilous. While a soft Brexit would find plenty of support on the opposition benches, it would likely rip the Conservative Party apart; indeed, that’s why May wanted to increase her majority in the first place. Moreover, it would require considerable forbearance from the UK’s European “partners” whose patience has been sorely tested by the UK’s demands over the last year or more. At this stage, it is not inconceivable that the absence of an effective government could send the UK crashing out of the EU without a deal.

Little Impact on Economy and Markets

So what does this mean for the economy and financial markets? In our view, there probably won’t be a significant near-term economic impact. However, the success of Labour’s anti-austerity message is likely to lead to a looser fiscal policy over time. This, plus increased political uncertainty—including the risk of a second election at which the Labour Party might do even better—will probably weigh on the gilt market. As ever, though, it’s the pound that looks most vulnerable. The one positive for sterling is that its downside is probably limited by hopes that last night’s fiasco will ultimately lead to a softer Brexit.

Finally, it’s worth asking how last night’s vote fits into our populism theme. On the surface, it fits very nicely. Jeremy Corbyn’s populist anti-austerity message has been a huge hit, particularly with younger voters. However, last night also showed big gains for Labour in areas that voted to remain in the EU, as well as a backlash against the SNP and its obsession with Scottish independence. So, all in all, yesterday’s election was actually a big vote for the status quo. Strange times indeed.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.