It seems a done deal that the Conservative Party will win the 2017 General Election and will increase its majority in the House of Commons. The Conservatives are around 17 points ahead in the opinion polls and the Labour Party’s election campaign to date can best be described as unfortunate. Senior party members appearing to have little knowledge of basic arithmetic and the leakage of the manifesto before the official launch haven’t helped.
The gilt market and sterling are heading into this political event with a reasonable sense of calm; unusual in the context of the last three years of potentially destabilising political events, starting back with the Scottish Referendum in 2014. The expectation appears to be that an increased majority in the House of Commons gives Theresa May the negotiating power to negotiate a ‘better’ Brexit. Many have interpreted this as ‘softer’ i.e. closer to the EEA (European Economic Area) or EFTA (European Free Trade Area)-type arrangements, rather than the imposition of hard borders and resorting to WTO rules regarding trade. This has led to sterling strength against the euro and the US dollar in recent weeks.
Unfortunately it is not clear what her Brexit negotiating stance is yet. On closer inspection of the opinion polls, we see that it is the UKIP support that has collapsed and switched to the Conservative Party. The Conservative manifesto has not been published (or leaked) yet so we are still to see if the currency and bond markets have made the right assessment of a ‘better’ Brexit. What we do know is that Theresa May is firmly rejecting the idea of Free Movement of Workers, with her commitment to reduce immigration to less than 100,000 per annum. This concept is completely at odds with the pillars of free trade in the EU, EEA and EFTA.
Sterling has appreciated over 2% on a trade-weighted basis over the year to date. Gilt yields have fallen from 1.5% at the 10-year maturity to closer to 1.0% as concern over imported inflation abates. It seems to me that although the outcome of the election is of little dispute, the outlook for Brexit and the UK remains uncertain, and the risks rise again on 8 June.