UK: Four final points on the election – Deutsche Bank

Oliver Harvey, Macro strategist at Deutsche Bank, lists down the four final points on the UK election which are important and suggests that firstly, a Labour government remains a very low probability outcome.

Key Quotes

“Parliamentary maths mean that the Conservatives would have to see their seats fall below 300 for any realistic prospect of a Labour minority government backed by the SNP, Liberal Democrats and other smaller parties. Despite Labour’s surge, no polls have indicated outright Labour Party leads, or predicted a Conservative seat share below 300 as a central scenario (YouGov’s model which is closest predicts 302 Conservative seats). A Corbyn government would therefore represent a larger shock/polling error than Brexit. The most likely outcomes for Friday morning range from a modestly market friendly 5060 Conservative majority to a much more bearish sub-50 majority.” 

“Second, our baseline remains a Conservative majority of between 50-60 seats. Our own model, which applies a uniform swing to English, Welsh and Scottish constituencies based on poll averages, and accounts for Brexit demographics, suggests a 57-seat majority. The Electoral Calculus website predicts a 72 seat majority. While our individual seat predictions are quite similar, we are less optimistic on Conservative performance in London.”

“Third, our baseline is already priced. Overnight vol remains subdued with one week implied well below levels for the Scottish independence referendum, 2015 general election and Brexit referendum. Overnight straddle breakevens also hardly look extreme relative to history. Meanwhile, our CORAX positioning report, suggests that last week’s selling pressure has abated and the market has been buying back the pound. In the event that we are wrong, we think GBP/USD can outperform the breakeven. The pound should weaken to more than its pre-election level as May’s political authority would be undermined and the starting point for Brexit talks is worse given the ramping up of political rhetoric with the EU27 into the election.”

“Fourth, our medium term outlook for sterling remains bearish. Even under an increased majority, May will find compromise with the EU27 over the Brexit bill and ECJ challenging. GBP fundamentals remain bearish, with this week’s services PMI doing little to alter a picture of slowing UK growth, leaving the Bank of England on hold as the ECB and Fed tighten. A Labour minority government pursuing soft Brexit with the SNP and Lib Dems is the biggest risk to this view, but is both unlikely and highly path-dependent.”

How could the UK general election affect the Forex Market?

Conservative victory with Absolute Majority (Scenario 1)

A Conservative victory with an absolute majority should be supportive initially for the pound. Stock markets would be relieved on the lower corporation tax outlook and a risk-on environment could be the expected outcome. However, with a focus on Brexit and PM May's hardline - "No deal is better than a bad deal" - approach to the negotiations, a hard Brexit outlook could equate to a bearish scenario to the pound eventually - (Note: Remain cautious of a 'buy the rumour sell the fact' trade - a Conservative victory is virtually priced in).

Conservative victory without Absolute Majority (Scenario 2)

With the narrowing of the polls and a trend that has been continuing, the possibility of a hung parliament should not be ruled out, (When no party has won enough seats to have a majority in the House of Commons). Such an outcome could be highly bearish for the pound due to the uncertainty for markets to deal with. However, in a hung parliament, the incumbent prime minister stays in office until it is decided who will attempt to form a new government - this could support the pound after an initial sell-off. (Note: A hung parliament does NOT necessarily mean a coalition government). 

Laborist victory (Scenario 3)

A balanced outcome for the pound with initial volatility on the basis of Labour’s manifesto. Initially, a lower pound could be the immediate outcome bias due to increased uncertainty and a reduction of inflows. However, a Labour victory should mean a softer Brexit outlook and austerity would be removed, (Fiscal easing lifting growth and inflation expectations). Higher real yields may offset the initial weakness in the pound. 

When is the UK general election 2017?

The United Kingdom snap general election is scheduled for June 8, 2017. The election will elect representatives for the 650 districts that make up the House of Commons, the lower house of the British Parliament.

Theresa May Called for UK Snap General Election

UK Prime Minister Theresa May has announced plans to call a snap general election on May 15th. Explaining the decision, Mrs May said:  "So we need a general election and we need one now. We have at this moment a one-off chance to get this done while the European Union agrees its negotiating position and before the detailed talks begin."