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A Conservative landslide paves the way for a Jan. 31 Brexit

How much of a surprise was yesterday’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

Important Information

Blog header image: schwartstock / Getty

All investing
involves risk, including the risk of loss.

Brexit refers to
the scheduled exit of the UK from the European Union.

UK gilts are
bonds issued by the British government.

The opinions
referenced above are those of the authors as of Dec. 13, 2019. These comments should not be
construed as recommendations, but as an illustration of broader themes.
Forward-looking statements are not guarantees of future results. They involve
risks, uncertainties and assumptions; there can be no assurance that actual
results will not differ materially from expectations.

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