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9th June 2017

UK Election result – weak and unstable government

  • UK election results in hung parliament
  • If no coalitions, Theresa May will come under pressure to resign
  • Risk of a “no-deal” Brexit increases

What’s happened

The results of the UK election point to a hung Parliament, with no party having overall control of Parliament, despite the Conservatives winning the larger share of the vote.

Coalition: The Conservatives or Labour could both race to form a coalition to get to a majority of seats (326 of 650), and then form a government. This is what the Conservatives and Liberal Democrats did in 2010.

Minority: The Conservatives or Labour could attempt to form a government despite a minority in Parliament, but this makes it harder to get legislation through.

The end of May? Theresa May will remain in position until a new government is formed (coalition or minority), but under any scenario will come under pressure to resign.

How did it happen?

May called a snap election while polling a majority. It was a calculated move to obtain a mandate to strengthen her position internally and against the EU in Brexit negotiations.

After a poor campaign – criticism for the so-called “dementia” tax on elderly care and a refusal to appear in debates – her strategy has entirely backfired.

Having made the case for a “strong and stable” government, we will now get the exact opposite.

There may be pressure on her to resign and trigger yet another leadership challenge.

Risk of “no-deal” for Brexit

Whether in coalition, or in minority government, the next government is going to have a weaker hand in Brexit negotiations.

Given a Brexit deal needs the support not only of the Government but of Parliament, EU Member States and their parliaments and the EU Parliament, there is an increased risk of a “no-deal” Brexit, which is the worst case scenario, as that has the potential to create the most frictional economic damage.

What it means for markets

Markets hate uncertainty, and a hung Parliament was a worst case scenario. In the short-term, sterling has weakened some -2% overnight, but in the medium-term it means that it will have little chance of strengthening above $1.30.

UK large cap equities are likely to be resilient, primarily due to the translation effect of sterling weakness. UK mid cap and small cap equities are likely to be volatile in face of increasing economic uncertainty.

Coalition or minority – the deadline

May will attempt to put together an alliance. If she can’t, and Corbyn can, she would be expected to resign and Corbyn would become Prime Minister.

Corbyn will also be attempting to create an alliance to achieve a majority. So smaller parties will have to decide who they side with.

If neither May nor Corbyn can form a majority coalition, then May can remain in power but with a minority government.

If coalition talks fail, either party could attempt to form a minority government which would be weak for getting legislation through and weaken UK’s negotiating position with the EU.

The deadline for coalition negotiations is Tuesday 13 June when the new Parliament meets.

Possible coalition options

The DUP and Lib Dems are now kingmakers in this election when it comes to creating a coalition.

The Conservatives could form a government with the support of either the DUP or Lib Dems in a similar fashion to what occurred in 2010.

For Labour to form a government they would struggle to get the seats required (see below)

Labour: (261) +  SNP (35) + Lib Dems (12) + Other (13) = 321 (vs 326 target)

Conclusion

May wanted an election to affirm her mandate to conduct the Brexit negotiations and the rationale for obtaining one was right.

It was designed to be a calculated risk. But after a weak campaign, and resurging support for Labour from younger voters, she now faces weakened or lost power.

Markets crave certainty and political risk can obstruct underlying economic trends.

There’s now no prospect of UK political risk receding in the short-term.

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