Brexit uncertainty increases as May’s electoral strategy fails

Author: Pieter Jansen, Senior Strategist Multi-Asset at NN Investment Partners

One reason why UK Prime Minister Theresa May called for snap elections less than two months ago was to extend her majority in Parliament. This strategy did not succeed. The Conservatives are still the largest party in Parliament but they fell short of an absolute majority by about eight seats. With no party having a majority, the UK is faced with a hung parliament. Labour is the main winner, with about 31 additional seats. The Scottish National Party (SNP) lost as well, reducing the momentum for another Scottish referendum.

Where do we go from here? This election result creates significant political uncertainty.

  • First, Theresa May’s position as PM is in question. Pressure on her to resign will increase further. If she does step down, we will enter another phase of internal election within the Conservative party, which may delay clarity on the Brexit strategy further. It is not yet clear whether May plans to resign.
  • Second, it does seem most likely that the Conservatives will form a government, either as a minority government or with the support of Northern Ireland’s Democratic Unionist Party (DUP). Such a majority would be very thin and the government would lack stability.
  • Third, the uncertainty surrounding the Brexit outcome rises further. On the one hand, the chance of a softer Brexit outcome increases as a softer position would help Conservatives gain a majority in Parliament. On the other hand, a no-deal outcome may become more likely. Finding a softer approach acceptable to the hard-liners in May’s party and to her EU negotiating partners may prove difficult or impossible, while a hard Brexit deal could fail to get the necessary support from the other parties in Parliament.

The initial market reaction confirms our view that the UK election primarily influences UK financial assets and particularly the sterling exchange rate. Sterling fell by about 2% initially versus the euro overnight. It should be noted that the pound had already fallen over the past month as the Conservatives’ lead in the polls declined and as the risk of a smaller majority increased. Since 10 May, sterling has fallen by about 5% versus the euro.

In a broader sense financial assets were not affected by the increased political uncertainty that will follow from the UK elections, with equities a bit higher. Going forward, pressure on sterling could remain as the uncertainty continues. For UK equities, this weakness is a support mainly for internationally exposed sectors, while it weighs negatively on domestic sectors and consumer exposed sectors. This is also reflected in today’s performance difference within UK equities, where the benchmark FTSE100 increased by 0.7% and the FTSE250 midcap index declined by 0.7%.