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UK Election Summary (9 June 2017)

Core Content

The UK general election on 8 June 2017 resulted in a hung parliament, meaning no single party had a clear majority. This outcome introduced significant political uncertainty and impacted financial markets across various asset classes, including FX, interest rates, and equities. The analysis provided by BNP Paribas outlines the potential implications of the election result and the likely path forward for the UK government and its economic policy.

Main Views

• Political Uncertainty: A Conservative minority government is expected to form with support from the DUP in Northern Ireland, though this is not an ideal fit. The Labour Party is unlikely to form a government due to the lack of clear support from other parties, including the Liberal Democrats and Scottish National Party (SNP).

• Brexit Impact: The election outcome raises concerns about the delay of Brexit negotiations, particularly if the Conservatives change leadership. A "softer" Brexit stance may emerge due to the need for cross-party cooperation, which could increase market uncertainty and affect the UK's negotiating position.

• Currency Outlook: The GBP is expected to weaken further, potentially testing post-Brexit lows around 1.20, especially if a Labour-led coalition is formed. The FX market is likely to re-establish GBP shorts, as uncertainty and the possibility of higher taxes and public borrowing could weigh on the currency.

• Interest Rates: The UK 10-year gilt ASW is expected to cheapen by 15 basis points, with a two-phase market reaction:

  • First Round: Initial risk-off sentiment could push gilt yields down by 10bp+, but inflation expectations may rise due to GBP weakness, limiting yield declines.
  • Second Round: Increased public borrowing and a potential shift to a "softer" Brexit could lead to a sell-off in rates, pushing yields upward.

• Equities Outlook:

  • The FTSE 100 is expected to underperform relative to its FX beta due to continued uncertainty and a weaker Brexit negotiating position.
  • The FTSE 250 is likely to underperform the FTSE 100 and eurozone equities due to sector-specific risks and a slower domestic economy.
  • Commodity-related sectors in the FTSE 100 are vulnerable to declining oil and iron ore prices, while the financial sector faces regulatory uncertainty.

Key Information

• Conservative Minority Government: Most likely, with support from the DUP. This could lead to early elections or policy challenges.
• DUP Support: While pro-Brexit, the DUP is socially conservative and opposes austerity, making cooperation with the Conservatives challenging.
• GBP FX Outlook:
  • Already fallen from 1.2958 to 1.2695.
  • May test post-Brexit lows if the market prices in a Labour-led coalition.
  • BNP Paribas suggests GBP shorts could re-establish, leading to further depreciation.
• Interest Rates Strategy:
  • Short 10y gilt ASW positions are favored due to:
    • Slower fiscal tightening.
    • GC-LIBOR spread widening.
    • High gilt issuance in Q3 2017.
    • Global QE reduction.
  • Two-phase reaction expected in the rates market.
• Equity Market Outlook:
  • FTSE 100 may benefit from GBP weakness, but underperform compared to eurozone equities.
  • FTSE 250 is expected to underperform the FTSE 100 and eurozone SMID-cap stocks.
  • Retail sales and consumer spending are expected to slow further due to inflation and uncertainty.
  • Online purchases may hurt retail margins.

Conclusion

The election outcome has created a politically and economically uncertain environment, with implications for currency, interest rates, and equity markets. The Conservative Party faces a difficult path forward, while GBP weakness and Brexit uncertainty are likely to pressure financial markets. Investors are advised to monitor political developments and consider short gilt ASW positions and risk management in light of these uncertainties.

Disclaimer

This document is non-independent research and marketing communication for professional clients and relevant persons. It does not constitute investment research or financial advice. BNP Paribas may have conflicts of interest and engages in transactions that may be inconsistent with the views expressed. All information is subject to change and not guaranteed for accuracy or completeness. Past performance is not indicative of future results.