This is only the second hung parliament since 1974. The Conservatives look to have won enough seats to form a minority government with some smaller groups. We see a new Conservative leadership race as likely at some point to replace Prime Minister Theresa May, who called the election on hopes of securing a bigger majority for a freer hand in Brexit negotiations. The winner of that leadership race will shape the U.K.'s negotiating stance with the European Union (EU) unless a new election is called. A new election is possible but would require two-thirds of parliament to approve.
We see this as a mild short-term negative for U.K. domestic assets due to the uncertainty and prospect of a weak government vulnerable to losing votes in parliament. We expect the Bank of England to keep its accommodative policies in place to support the economy through the uncertain negotiation period, looking beyond any short-term inflation spikes unless price pressures become sticky.
We also now see a wider range of potential outcomes, including a softer Brexit in light of parliament's new makeup.
We see bigger risks of an economically disruptive "no deal" Brexit - one that leaves the U.K. without existing trade or security agreements by the hard March 30, 2019 deadline. A minority government may be hostage to eurosceptics and others hostile to making concessions to the EU. But we also now see a wider range of potential outcomes, including a softer Brexit in light of parliament's new makeup.
The pound should remain a good barometer of Brexit risks, we believe. One market positive from the election is the reduced risk of another Scottish independence referendum. We see the election outcome as a U.K. domestic issue and don't expect broader ramifications for global markets.
The EU is willing to do a deal, we believe, but wants to draw a clear line between the benefits and responsibilities of members versus non-members. The EU has other priorities. New French President Emmanuel Macron looks poised to build on his win with a parliamentary majority that may make it easier to pass business-friendly reforms. Macron and German Chancellor Angela Merkel are leading a revived drive to reform the EU, a bigger priority than spending energy haggling over Brexit terms.
The big question is whether an outline agreement can be reached by the hard March 2019 deadline. The main two sticking points: the size of the U.K.'s exit bill - reported to be €60-100 billion - and a deal on citizens' rights on both sides, including any ongoing role for the European Court of Justice. The EU wants to settle these issues before discussing any future relationship. The EU is likely to give the U.K. some time before beginning any formal discussions, originally scheduled for later this month. We believe the U.K.'s uncertain political outlook means the timetable for reaching an agreement is even more compressed, with the clock already ticking.
Article was originally posted in BlackRock Insights on BlackRock.com
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