UK general election: light at the end of the tunnel?
The 8 June snap election in the UK resulted in a hung parliament, with no single party gaining an absolute majority. For markets, this was the bleakest and least expected outcome. It heralds a period of political instability, just when the countdown to Brexit is commencing. Sterling suffered in the immediate aftermath, dropping as much as 2.5% against the dollar in trading on 9 June. Prime Minister Theresa May had called the early election with the specific aim of bolstering her parliamentary majority. At the time, opinion polls were suggesting that her Conservative party would win an overwhelming victory and could add at least a hundred seats to her existing majority. May’s plan for a “hard-but-smooth” Brexit – quitting the single market and the customs union then transitioning to a tailored free-trade agreement – would arguably have had a greater chance of succeeding because it was less likely to be thwarted by the opposition or the extreme Eurosceptic wing of her own party. Even though the polls of voting intentions showed that the Conservatives’ lead over Labour was narrowing in the run-up to the election, most pollsters (with the exception of YouGov) were still predicting a win and a bigger majority for May on the eve of the voting.
In the end, the Conservatives did win, taking 42.4% of the vote versus 40% for Labour, but they forfeited their majority in parliament, losing 13 seats compared with the 2015 election. They took 318 seats, eight short of the number needed for an outright majority. The reasons for the defeat include a lacklustre campaign by May, refusal of her ideas on the terms ofBrexit, and her U-turn on the proposed reform of the social care funding system, which undermined her image as a leader. The situation was compounded by two terror attacks, for which she was held partly responsible for having cut thousands of police jobs when serving as Home Secretary in the previous government. By contrast, Labour was buoyed by the surprisingly successful campaign of its leader, Jeremy Corbyn. The party raised its 2015 election tally by 30 seats on Corbyn’s proposals to boost public investment, raise taxes for the wealthy and scrap university enrolment fees, as well as plans to nationalise utilities and transform the social security system. The high turnout rate of 68.7%, up 2.6 points on 2015 thanks to the mobilisation of young voters, vindicated Corbyn’s policy choices. Labour now has 262 MPs in the House of Commons. The Liberal Democrats made a slight gain of four seats and ended up with a total of 12 MPs. The Scottish National Party lost 21 seats as the Conservative vote surged.
What happens now? The Conservatives are striving to remain in power by forging an alliance with the Democratic Unionist Party of Northern Ireland, which has ten seats at Westminster. Both parties are on the centre-right and the DUP is an ardent Brexit supporter (even though Northern Ireland voted to remain in the EU). Nonetheless, under pressure from both her own party and the opposition, Theresa May could be forced to step down. If the Conservatives fail to form a government, it will be up to Labour to try and put together a coalition of parties on the left: the LibDems, the SNP and the Greens. That will be a tough task, thus increasing the likelihood of a fresh election.
The general election outcome has led to a sharp increase in political uncertainty, both at home and abroad. No scenario is off the cards. In the short term, May’s botched campaign has seriously weakened her premiership and she will very probably be forced to resign in the coming months. Media reports suggest her likely successor would be either Boris Johnson, the foreign secretary and a hard-Brexit supporter, or Philip Hammond, the finance minister, who campaigned to remain in the EU and now supports a soft Brexit. These alternatives illustrate the binary nature of the future scenarios. A fresh general election cannot be ruled out; neither can the possibly of a second referendum. The resulting uncertainty will weigh on the economic outlook going forward, and it will very probably prompt us to lower our forecasts for the UK for this year and the next. The unsettled political environment is highly unconducive to investment. Moreover, a further decline in the value of sterling will produce a steeper than expected fall in real household incomes and hurt consumption, while the effect on net exports will not be enough to prevent a sharp economic slowdown.
As far as Brexit is concerned, the coming days and weeks will be vital for assessing any changes the government might make to its strategy. One certainty, however, is that the election result shows – at least to some extent – that the British people have spurned Theresa May’s Brexit plan. Britons want to leave the EU but they don’t want a hard Brexit. The business community is broadly critical of the prime minister’s plan to leave the single market and the customs union, as well as her harsh, anti-liberal stance on immigration, with a proposed cap of 100,000 net immigrants annually. In consequence, the government will have to rework its plan in favour of a softer Brexit, one that would be more acceptable to businesses and probably mean remaining in the single market and the customs union.
That reorientation is particularly necessary because a minority government, or a coalition with a slim majority, is inherently unstable and could be blocked by the opposition when voting on important issues. Significantly, all the left-wing parties – Labour, the LibDems, the SNP, the Greens and Plaid Cymru – are categorically opposed to Theresa May’s hard-Brexit plan. The arithmetic of the Conservative’s own parliamentary seats will also play a key part in determining future events: will it be the pro-EU ranks, backed by Scottish Conservatives, that take the lead in negotiating with the EU-27? Or will it be the extreme Eurosceptic wing of the party, which wants to leave without an agreement? The Tory-DUP alliance nevertheless raises hopes of a soft Brexit because of the issue of Northern Ireland’s border with the Irish Republic.
The task facing Mrs May – or possibly her successor – is a doubly complicated one: if Brexit is seen as too soft, her own party might defy her, whereas a hard Brexit is likely to be blocked by the opposition. Major disagreements within the Conservative party and in Westminster, as well as the absence of a clear roadmap, could waste valuable time in an already-tight schedule and, come 29 March 2019, could leave the UK without a free-trade agreement with the EU, its biggest trading partner. As a result, there is a greater likelihood that one of two extreme scenarios would prevail: on the one hand, a soft Brexit (the so-called Norway model); on the other hand, no agreement (hence the World Trade Organization rules would apply). So where does the happy medium lie? If no agreement is reached, it would be very costly for the UK and the economies most exposed to it. A “bare bones” agreement would have to be reached – probably at the eleventh hour – in order to avoid a bumpy exit, with a default solution consisting of membership of the European Economic Area.
Slavena Nazarova, Economic Studies of Crédit Agricole S.A.