Last night’s UK election result (Figure 1) represents a small positive for the UK growth outlook. A hung parliament, and a minority Conservative government, marginally reduces the likelihood of Brexit taking place. It certainly diminishes the likelihood of the hardest of Brexit scenarios where the UK leaves under WTO rules and without a transitional customs deal which despite campaign rhetoric to the contrary would be the most damaging outcome.
A minority government will have to provide concessions, likely on higher public spending and a softer Brexit deal, to maintain any supply and confidence arrangements. This higher public spending profile, and softer Brexit, represents a positive medium term upgrade to UK growth.
The one sector that is likely to come under sustained pressure is set to be UK financials and real estate. Here the uncertainty over fiscal policy and in particular the possibility of Labour pushing for higher property taxation (to appease their youthful support) represents a protracted threat to this sector.
However from a broader market perspective it is worth remembering that FTSE100 and FTSE 250 have a >+0.85 cross-correlation to the US equity market (Figure 2) and therefore domestic politics will, in our view, have little impact on the overall trajectory for UK equities.
We expect the short term pressure on GBP should bottom out around 1.25GBPUSD and then strengthen once reactionary trades have unwound. We upgrade our price target from 1.30GBPUSD to 1.35GBPUSD. We also reaffirm our view that UK monetary policy will remain unchanged throughout the remainder of this decade.
Some commentators believe that the UK’s negotiating position on Brexit has been fundamentally weakened. I do not share that view. The UK’s ability to negotiate a positive outcome was already impaired - and the lack of a workable majority does not alter that calculation. The more material impact will be domestically, where “pork barrel” politics representing additional public spending will be the order of the day. This will be the currency to facilitate a confidence and supply arrangement.
It seems inconceivable that Theresa May can survive long term as Prime Minister however her personal resilience, looming Brexit negotiations and the lack of a compelling alternative leader could mean a stay of execution. We expect a Cabinet reshuffle could pave the way for a transition of power at the end of the Article 50 process; however the composition of the House of Commons does lend itself to a Second General Election later in 2017.