How much of a surprise was Thursday’s UK election outcome? Actually, it was very similar to the seat-by-seat projections we published a month ago, which forecast a clear Conservative majority in Parliament. The difference is that the Conservative Party won a few more seats than we expected (365), as did Labour (203), and the Liberal Democrats did much worse than we anticipated, taking 11 seats.
What does this mean from a political perspective?
- We have more certainty that the UK will leave the European Union (EU) by Jan. 31.
- We can expect pragmatism when it comes to deciding on an extension of the transition period. UK Prime Minister Boris Johnson’s experience in negotiating the Withdrawal Agreement suggests he will be reluctant to risk waiting until the end of 2020 and exiting under terms set by the World Trade Organization.
- From a relatively thin manifesto, the Conservatives will now be able to plan confidently for a term of at least four years – meaning they can begin to think more radical thoughts about shaping their agenda.
- With an eye on history, Johnson will want to ensure a second term as prime minister, so we expect him to forge a centrist path that seeks to maintain the current coalition of Conservative voters.
- The Nationalist Party made a near-clean sweep in Scotland, which may threaten the integrity of the UK if further pressure builds for a second referendum on independence.
What does this mean for Brexit?
All of this points to Brexit being completed by the end of January, but trade negotiations on the future relationship being stretched out beyond December 2020. It also suggests that the UK could exit the EU’s single market (a central issue for the UK’s world-beating service industries) but still maintain close regulatory alignment for goods (a central issue for the regional economies where the Tories made major gains).
Sterling jumped on the election results, presumably on the assumption that a Conservative majority of 80 will allow Johnson to not only get Brexit done by Jan. 31, but also to negotiate a soft Brexit with the EU. This could allow him to extend the negotiation period with the EU to beyond the end of 2020 (which was his previous deadline) and come up with an outcome that involves closer alignment with the EU and less short-term disruption to the UK economy (but may also reduce the scope for deals with other countries, especially the US).
Economic and market implications
The Tories made major gains in the Labour Party’s northern heartlands – the more industrial-focused “Old Economy” England. Johnson will likely try to consolidate those gains without losing the prosperous Tory heartland in the South, so we expect that he would ideally encourage the “Old Economy” and services industries, as well as support innovation and technology for the “New Economy.”
In our view, the economic effects should be a gradual and sustained recovery in investment and a reversion to a higher growth rate between the eurozone and the US (though probably slower than pre-Brexit economic growth). We would expect an early increase in investment, but not a dramatic release of pent-up demand, as partial uncertainty about the speed and nature of the future relationship with the EU will persist, restraining animal spirits.
If so, sterling is likely to consolidate some further gains, but still at a discount to pre-Brexit levels. Gilt yields could move somewhat higher still. Equities are likely to rise significantly. With uncertainty easing, the Bank of England might even attempt to catch up to the global easing frenzy with a rate cut.
With contributions from Graham Hook, Head of UK Government Relations and Public Policy for Invesco