Another vote, another tough outcome for the UK electorate.

No outright winner came from the 8 June General Election. Instead, we came away with a hung parliament as all major UK political parties suffered some form of loss:

• The Conservatives lost their parliamentary majority
• The Labour Party gained the moral victory, but still came second to the Tories
• The Liberal Democrats failed to see support for a second referendum
• The Scottish National Party lost seats to Labour and the Conservatives, suggesting no 2nd Scottish independence referendum
• UKIP won no seats at all

We are left with a confusing picture of government that hinges upon some form of agreement being struck between Theresa May’s Conservatives and the Northern Irish Democratic Union Party (DUP), an oft-controversial group known for its hard-line religious views.

What could possibly go wrong?

The confidence and supply agreement currently being negotiated – only used once in the past 50 years in 1977 and lasting only 18 months – means the DUP would be expected pledge support for major Conservative policies for minor kickbacks. Should the party decide to withdraw support May’s government, for whatever reason, the Tories would then be forced to form a minority government or a second general election would have to take place.

Even more pressing, should talks between the Tory Party and the DUP fail (note that the NI assembly itself has been out of action since January after Sinn Fein walked out on the power sharing agreement due to a DUP corrution scandal), and no official government is put in place, then the opposition – Labour – would have the opportunity to form a minority government.

Given the deeply complicated history of Northern Irish politics (the DUP only ratified the 1998 Good Friday agreement nine years later), this seems as though it could almost be an inevitability, especially with the touchy subject of the Northern Irish border needing to be settled before full negotiations can begin.

Furthermore, ongoing media reports of supposed Tory opposition to Theresa May’s leadership poses the potential for a leadership bid from within her own party. This would come about if 15%, or 48 Conservative MPs, tabled a motion of no confidence in the Prime Minister. The Conservatives would remain in power, but the government would be led by a different PM.

What could this mean for markets?

If there’s one thing that markets hate, it’s uncertainty.

The absence of a clear winner ahead of arguably the largest negotiating task for UK diplomats since the Second World War is far from what markets would have wanted. The subsequent Sterling weakness reflects this, although this offers a perverse boost for the the UK’s blue-chip UK 100 index. With the majority (>70%) of stocks on the index either reliant on the exporting of goods and services or reporting earnings in a foreign denomination, strength in the Euro and US dollar would have a positive impact.

Political uncertainty also plays badly for the Bank of England which, having tolerated the post-Brexit inflation overshoot, will come under increasing pressure to react as Real Wages decrease and CPI continues to accelerate. Analysts at HSBC and Deutsche Bank predict that this latest political drama could push back the BoE’s timetable to act until 2020. With the Wage/Inflation divergence looking set to continue, this could be particularly damaging for the average Brit’s wallet.

Should any of the aforementioned events come to fruition, it is likely that Sterling would fall further against both the Dollar and the Euro as uncertainty sees investors engage in risk-off trading, cutting riskier trades for ‘safe bets’ – defensive stocks or safe-haven assets such as Gold or the Japanese Yen.

The UK government hangs in the balance but, for the good of the markets, can a deal be hammered out behind closed doors? The clock is ticking.

———–

Henry Croft, Research Analyst, 13 June