UK elections: A hung parliament

  • The lack of a Conservative majority realises a hung parliament. The impact of this on Brexit is hard to predict.

  • Markets are likely to move into ‘risk-off’ mode seeing a decline in sterling, UK equites and gilts.
  • Investors should prepare for increased market volatility as we expect a chaotic and difficult time for Westminster. 

Brexit negotiations

A hung parliament has now kickstarted a very chaotic and difficult time for Westminster, the outcome of which is difficult to envisage. Could we see Labour and the SNP cobble together a coalition (maybe with the help of the Lib-Dems)? In any case, the UK’s departure from the European Union looks set to be delayed or turned into a very Soft Brexit.

What are the implications for UK assets?

Sterling

Since the referendum on 23 June 2016, the British pound exchange rate has been the best barometer for the market’s perception of the risks and opportunities.

After falling more than 15% in trade-weighted terms during 2016, sterling recovered almost 8% from the beginning of 2017 through the end of May 2017. However, it quickly fell back by 3% in May as the Conservative polls started to narrow during the run up to the election.

Looking ahead, we think the pound will fall initially, but the downside is limited by favourable valuations (see chart).

Equities

Equity markets will fall on the back of heightened political uncertainty. The expected fall in equity markets is likely to be softened by a weaker pound, but the medium-term outlook for stocks very much depends on how the political uncertainty is resolved.  Overall, the outlook for UK stocks is also closely linked to global economic prospects.

Quote: “The main conduit for changes in asset prices will be via sterling, and here the effect will be limited to the UK stock market.” – David Vickers, Russell Investments Portfolio Manager

Gilts

In such an environment, we project that 10-year Gilt yields will fall in a risk-off move. If the formation of a government is delayed significantly, this may eventually lead to a review of the UK’s credit rating and higher yields

Economic outlook

Our bottom line is that while this general election result feels like a crucial event for those in the UK, it does not carry with it the same market significance as others have over the past year, namely the French or Italian elections. Indeed, the post-Brexit economy has done well so far, but we continue to believe that the slowdown in corporate and housing investment in combination with downward pressure on real wage growth will slow economic growth in 2017 and 2018.