UK’s winter election: What’s in it for markets?

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UK's winter election: What's in it for markets?


LONDON (Reuters) – Britain’s election on Thursday is widely referred to as the most important in a generation given the impact it will have on the country leaving the European Union and choosing between starkly opposed economic paths.

FILE PHOTO: A broker looks at financial information on computer screens on the IG Index trading floor in London, Britain February 6, 2018. REUTERS/Simon Dawson

As such, its outcome is expected to have both a strong short-term impact on trading floors but also a long lasting structural influence on UK financial asset classes, be it sterling, government bonds or stocks.

Investors have so far been pricing in an outright majority for Prime Minister Boris Johnson’s Conservative Party.

The assumption that such an outcome would end Brexit uncertainty and rule out Labour’s radical agenda has boosted the pound GBP= to a seven-month high against the U.S. dollar and lifted London’s mid-cap stocks .FTMC to levels unseen for over a year during most of the campaign.

A closely watched forecast released on Tuesday evening has however sent jitters across the markets, denting sterling and domestic stocks. It showed the race tightened and that Johnson was likely to win only a modest majority.

“At the moment, I still think Conservative majority is the most likely option and despite the reduction in sterling, that does still seem to be the option that markets are still pricing in,” said Rachel Winter, associate investment director at Killik & Co.

“But having said that, I don’t think anyone will be surprised to see a hung parliament.”

Following are a number of scenarios for British stocks, sterling and bonds based on some of the possible electoral outcomes:

BORIS JOHNSON GETS A LARGE ABSOLUTE MAJORITY

This scenario is considered to be the most market friendly. With a clear majority, Johnson would be expected to deliver the Brexit withdrawal deal he negotiated with the EU.

Although it is seen as a relatively hard form of Brexit by excluding UK-wide customs union membership, implementing it would avoid, on the short-term, a damaging ‘no deal’ Brexit and remove the uncertainty which has weighed on investments in the UK.

A Tory victory would be expected to be an immediate win for UK-focused companies such as housebuilders like Persimmon (PSN.L), Barrett (BDEV.L), Gleeson (GLEG.L), Bellway (BWY.L) and Galliford Try (GFRD.L).

Domestic banks Lloyds (LLOY.L) and Royal Bank of Scotland (RBS.L) would also be expected to do well.

The pound wouldn’t be expected to regain all the ground lost since it traded above 1.50 dollars before the referendum, but a rise to $1.35 and above is seen probable.

The rising pound would however weigh on the most internationalized dollar-earning UK blue chips, from consumer staples like Diageo (DGE.L) to big pharmaceutical groups such as GlaxoSmithKline (GSK.L) or miners like Glencore (GLEN.L).

The pledge by Johnson’s government to cut taxes and put an end to a decade of austerity via increased spending in education, police and health may also raise yields of corporate and government bonds.

HUNG PARLIAMENT

No majority for either of the two main parties is definitely seen as a negative as it would re-ignite Brexit uncertainty and prolong yet again one of the worst political crises Britain has seen since the Second World War.

But the exact results of an inconclusive vote would be key to who exactly forms the next government and would affect whether formal coalitions could be formed. There are many ways it could unfold and impact markets.

In any event, retailers and all businesses for which Christmas sales are key may be heavily impacted.

CONSERVATIVES-LED COALITION

With no absolute majority, Johnson’s campaign pledge to “get Brexit done” by January 31 2020 would require a divided opposition or securing allies from other parties’ benches to get his EU exit deal through Parliament.

The uncertainty would most certainly bring the pound and UK domestic shares back down to where they were before the election was decided on.

A razor-thin absolute majority could also give a handful of Conservative eurosceptics the opportunity to rock Johnson’s deal or complicate his bid to get a trade deal agreed with the EU in 2020.

CORBYN WINS AN OUTRIGHT MAJORITY

Chances of Labour leader Corbyn securing an absolute majority are priced below 5%. A surprise victory would therefore result in a shockwave for the British stock market even if Labour’s softer stance on Brexit could offset the impact further down the road.

On one level, sterling and Brexit-sensitive stocks may be buoyed by Labour’s plan to secure a softer Brexit deal and a second referendum.

But it’s not uncommon even for pro-EU investors to argue that a managed Brexit would be less damaging to the economy than Corbyn’s radical agenda to steer Britain’s economy to the left through large-scale nationalizations notably.

Consequently, even if a no-deal Brexit is ruled out and a second referendum on the cards, a surprise Corbyn victory would likely hit Britain’s equity markets hard. Corporate earnings growth would be expected to fall due to tax increases.

Labour’s campaign pledge to nationalize water groups, gas and electricity firms, rail operators and Royal Mail (RMG.L) has fueled a so-called Corbyn Risk Premium on these sectors.

Outsourcing companies such as Interserve [ISVJF.PK] or Serco (SRP.L) would be expected to get less business from a Labour government than a conservative administration seeking to further privatize the economy.

Corbyn’s reluctance to engage in high military spending could also weigh on defense contractors such as BAE Systems (BAES.L), QinetiQ (QQ.L) and Babcock (BAB.L).

UK-focused high-end retail groups such as Pendragon (PDG.L) could suffer as well as life insurers .FTNMX8570 should tax reform reduce the disposable income of higher earners.

Britain’s financial sector as a whole may be hit with tighter regulation and taxes, but it would likely be easier for banks with an international footprint such as HSBC (HSBA.L) to weather the storm.

REMAIN ALLIANCE? LABOUR/LIBERAL DEMOCRATS/SNP/GREENS

If the Conservatives fall well short of a majority and are unable to form a workable government, Labour, the anti-Brexit Liberal-Democrats and the SNP – and possibly other minor pro-Remain parties such as the Green Party – could try to form a coalition of their own.

After a moment of disappointment, sterling may warm to the outcome given the promise of a softer Brexit deal and a possible second referendum to keep Britain in the EU.

Many also reckon the Lib-Dems would keep Labour’s more radical program in check, limiting the hit to exposed market sectors and sentiment.

SCOTTISH NATIONAL PARTY THE KING-MAKER

With a constituency that overwhelmingly favors remaining in the European Union, the Scottish National Party is expected to do well in the election with its firmly anti-Brexit stance.

If in any subsequent coalition talks, the SNP sought assurances on another independence referendum for Scotland in 2020, that could pressure sterling and Scotland-based companies such as Royal Bank of Scotland (RBS.L) and Standard Life Aberdeen (SLA.L).

Reporting by Julien Ponthus and Sruthi Shankar; Additional reporting by Danilo Masoni, Joice Alves, Thyagaraju Adinarayan and Saikat Chatterjee; Editing by Hugh Lawson



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