Markets had been expecting that Britain’s Conservative government would be returned with an increased majority in last week’s UK general election, with both UK stock and bond markets making gains over the course of the campaign.
In a big surprise, though, the Conservative Party lost its majority, although it still looks set to form the next government as a minority administration, with the support of the DUP. Prime minister Theresa May intends to lead the new government, but questions are being raised about her long-term political future.
Sterling lost ground on election night, falling by 1.5%-2% once a key exit poll pointed to a hung parliament.
The impact on the currency may have been contained by the fact that it weakened in the run-up to the election, especially against the strengthening euro, as polls showed a narrowing of the Conservative lead over Labour.
The fall-out in financial markets from the election was largely confined to sterling. Global stock markets were not really impacted and made gains the day after the election.
Indeed, the FTSE 100 rose by 1% on the day, while the FTSE Mid-Cap 250, which is more representative of the domestic UK economy, recovered from a shaky start to end the day virtually unchanged. The new minority Conservative government will soon have to commence formal negotiations with the EU about the terms for Brexit. The election result adds to the already considerable amount of uncertainty around Brexit. It also makes it difficult for the UK government to get an exit deal through Parliament without opposition support, given that it no longer has a majority.
Indeed, there is much speculation that the election outcome could increase the prospects of a ‘soft’ Brexit, meaning one maintaining free trade.
The minority Tory government will have to be more cognisant of the views of the opposition parties in the House of Commons, which tend to favour reaching a deal with the EU and a softer Brexit.
Meanwhile, the ‘hard’ Brexit Ukip performed very badly in the election, and Ms May’s tough line on Brexit in the election does not seem to have worked either with voters.
Improved prospects for a soft Brexit may be one reason why the fall-out from the surprise election result for sterling and the UK financial markets has been limited enough.
The negotiations on Brexit, though, are still likely to prove very difficult.
The talks with the EU Commission could commence as early as next Monday, June 19, although there is some speculation that this start date might be delayed somewhat.
The negotiations are expected to last until the end of next year so it is going to be a long process.
The UK does not start the negotiations from a position of strength. It will now have a weakened minority government facing a united EU.
Brexit will have a bigger impact on the UK economy than on the EU. The agenda and timeline for the talks are being set by the EU and the UK does not have a veto on the final terms of any Brexit deal.
Ms May has frequently stated that no deal is better than a bad deal. However, it is hard to envisage a worse outcome for the UK than leaving the EU with no deal, given its very close trade links with the EU.
A key part of a soft Brexit will be transition arrangements that minimise the disruption to trade in the period between when the UK leaves the EU and concludes a broad free trade deal with it.
This will require compromises by the UK.
The prospect of such an outcome, though, has increased following the result of the British election.
Oliver Mangan is chief economist at AIB
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