May's day coming in June
In an unscheduled announcement, Theresa May has declared her intention to call a general election on 8 June. This snap election will be almost three years ahead of schedule. Below we address the five most pertinent questions likely to be on investors’ minds.
1. How is an early election possible under the Fixed Term Parliament Act?
The Fixed Term Parliament Act was introduced by the coalition government in 2011 to take away the Prime Minister's power to unilaterally dissolve parliament, thus triggering a general election. Since then, a general election, which falls outside of the fixed schedule, requires the consent of two-thirds of MPs.
However, this is a moot point. In the wake of the PM’s announcement, the Labour party have already said that they will vote in favour of dissolution. The House of Commons will vote on the motion “that there shall be an early parliamentary general election”. This should be a formality given that the two largest parties have over 85% of seats between them.
2. Why now?
The decision to call another general election is a combination of opportunism and political calculus from the Prime Minister.
The opportunity stems from opinion polls published over the weekend showing the largest Conservative polling lead since the early 1980s. In fact, it is hard to find a significantly larger Conservative lead in opinion polls stretching back over the last 67 years (see chart below). Moreover, local elections in Scotland and parts of England are scheduled for 4 May. A strong Conservative showing at those elections would frame the narrative for the subsequent general election campaign.
The calculus stems from the government’s working majority of just 17 MPs. That majority is vulnerable to fracturing under the pressures of the legislative agenda associated with leaving the European Union. A larger majority would give the PM greater discretion on both her Brexit and domestic agendas.
3. What’s the likely outcome?
Opinion polls have been unusually clear in recent months: a general election is likely to see the return of a Conservative government with a majority in the region of 100 seats. For a point of comparison, the 'landslide' victories of Margaret Thatcher and Tony Blair saw government majorities of roughly 150 seats.
However, as the last twelve months have demonstrated, there are no foregone conclusions in politics. Important events over the next few weeks that could change public opinion include the local elections, the publication of party manifestos, and televised debates between the party leaders.
4. How does this affect the Brexit process?
Yesterday's announcement has no direct impact on the government’s timetable or objectives in negotiation with the EU on the terms of withdrawal. Some of the smaller parties (e.g. the Liberal Democrats) may attempt to turn the general election into an implicit second referendum, but there is no turning back the clock on the overall process.
However, it may have two important indirect impacts that reduce the likelihood of a hard rupture with the EU.
First, a larger Conservative majority would reduce the influence of those MPs prepared to tolerate a disorderly departure for ideological reasons.
Second, it removes the political imperative to have a clean break with the EU in place by 2020 (the previously scheduled election date). A lengthy transition/implementation phase after the eventual agreement has arguably now become more likely.
5. What’s the potential market impact?
As with the EU referendum last year, we think that political risk will primarily play out through the currency channel. We have been arguing since last October that the risks are tilted towards a stronger pound as the UK’s external deficit shrinks and fears of a Brexit-induced collapse recede. Nothing in this announcement changes that view: we therefore continue to recommend lower than normal foreign currency exposure in anticipation of sterling appreciation.
A stronger currency has a number of cross-asset implications. Most importantly, it implies a marginally weaker outlook for UK equities (a stronger pound depresses the value of overseas earnings), and a lower path for inflation breakevens (a stronger pound pushes down the price of imported goods). The impact on UK nominal yields and sterling-denominated credit are much less clear.
Beyond the currency effect, we should not overstate the importance of a UK general election when thinking about the outlook for domestic equities. The French presidential election, or events on the Korean peninsula, are more likely to have a material impact on the FTSE given the interconnected nature of global markets. There may be important sector implications, but these will only become apparent with the publication of party manifestos in due course.