Investment Clock insights

Market impact of hung parliament depends on Brexit policy

Trevor Greetham

15 June 2017

First published in Investment Week 15 June 2017. Click here to view.

For the second time in the last three General Elections the British public has in effect voted for ‘none of the above’. Neither the Conservatives nor the Labour Party can command a majority in the House of Commons. Betting odds put the chance of a hung parliament in 2017 at less than one in five so this was a surprise to rival the EU referendum outcome and the election of Donald Trump last year. If President Macron’s victory in France is any guide, you are still most likely to win elections from the centre, even in the highly polarised social media world.

Market reaction has been very muted to-date as Theresa May looks to have secured a working majority with the help of the Democratic Unionist Party (DUP) of Northern Ireland. The UK’s Fixed Term Parliament Act means minority rule could last a long time, possibly the full five years. With the Conservatives unlikely to ask the opposition to back another snap election, the government would have to lose a confidence vote for an earlier election to take place and this would only come to pass if we saw a break down in relations with the DUP or an extended series of failed by-elections.

Most of the time investors need pay little attention to politics. The business cycle and human ingenuity are the main drivers of interest rates and corporate profits growth. However, an outright victory by Jeremy Corbyn would certainly have moved markets, not least the share prices of the privatised utilities he would like to take back into public ownership. In the current minority government scenario the markets are most interested in the kind of Brexit we are likely to see as this will impact the longer-term economic outlook and the level of sterling.

The Prime Minister failed to win backing for a tightly controlled Brexit process focused on cutting immigration and leaving the Single Market and yet, at present, both party leaders continue to argue in favour of just such a policy. This may change. Opponents of Hard Brexit within both parties will argue that the public mood is one of compromise. According to a recent YouGov poll, most people would like the government to negotiate to stay in the Single Market and maintain free movement with the European Union. The DUP may also push for a softer approach given the importance of maintaining a frictionless border with the Irish Republic.

If the UK government continues with its current strategy we would expect the economy to slow and there will be bouts of sterling weakness, particularly if it seems likely that the UK will leave with no deal. However, moves towards a softer Brexit along Norwegian or Swiss lines could see sterling strengthen and bond yields rise. While this would be a positive long-term scenario as far as the UK economy is concerned, it may mean lower returns on multi asset funds in the short term as last year’s gains on overseas investments reverse.

Arguably, while the election was meant to be about Brexit it was really about austerity. The surge in Labour support was a rejection of the cuts to public services and benefits that have been a permanent feature in the UK since the financial crisis. This has not gone un-noticed and a need to appeal to younger voters is likely to see the Conservatives dial down austerity. This could have a positive effect on the economy but gilt yields may end up rising over the next few years. The tight fiscal, loose monetary policy mix since the financial crisis has seen yields drop to extremely low levels. An increase in government spending would mean a reflationary economy and - ultimately – higher interest rates. Both are negative for bonds.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.