The markets adjust their Brexit calculations

SOMETIMES the markets are genuinely surprised. On the morning of April 18th, news that the British prime minister was to make an announcement at 11.15am caused the pound to dip. What could the news be? Retirement due to ill health? Several pundits went on Twitter to proclaim their belief that it would not be an early election; after all, Theresa May, the prime minister, has said repeatedly that the poll would not occur until 2020. But the news was indeed that an election will happen on June 8th. The pound then stormed higher and is now more than $1.28, around its strongest level this year (but well below the $1.50 touched on the day of the Brexit referendum).

So what explains the switcharound? The hope is that the election will lead to a softer Brexit result and thus be better news for the British economy. Deutsche Bank, previously bearish on sterling, was the most prominent convert to this view.

First, it makes the deadline to deliver a “clean” Brexit, without a lengthy transitional arrangement, by 2019 far less pressing given that no general election will be due the year after. Second, it will dilute the influence of MPs pushing for hard Brexit, strengthening the government’s domestic political position and allowing earlier compromise over key EU demands for a transitional arrangement. Third, it strengthens the PM’s overall negotiating stance who in recent weeks has clearly fallen in line with the European approach. This will involve a settlement of the Brexit payments and other divorce aspects first to be followed by a lengthy transitional period during which the final outcome of Brexit will emerge. This sequenced approach materially reduces the “crash risk” of Brexit negotiations and…reduces downside risks for the UK growth outlook.

This may turn out to be right but it is quite a bold call. The situation is pretty complex. First, one must discount the view that the government is calling an election because their Brexit negotiations are being hampered by the hapless Labour opposition and nine Liberal Democrat MPs. The government has not been defeated on the issue in Parliament; its margin for triggering Article 50, the key clause for leaving the EU, was 384 votes. Instead, Mrs May had to worry about her own backbenchers, many of whom will resist any compromise with the EU, on continuing payments, jurisdiction of the European Court of Justice, migration and the rest. Will there be more hardliners if the Conservatives increase their majority, or fewer? It all depends on the attitude of the new MPs that will come through in June; one doubts that Deutsche has analysed this. Europhile Tories like Ken Clarke are few these days; although the former Chancellor is standing again for Parliament, having previously announced he would step down. One local party chairman has written an article on the Conservative Home website with the headline: Let’s seize our chance to purge our Party and deselect the Remainers

We also know that Mrs May will face consistent pressure from the right-wing press, which is highly Eurosceptic. The Daily Mail’s headline the day following the announcement was “Crush the saboteurs”, which rather puts the PM’s rhetoric about “the country coming together” into context (the Mail's phrase was originally used by Lenin). A lot may depend on how a “hard” and “soft” Brexit is defined; the government seems to have ruled out membership of the single markets and the customs union. This would have been regarded as a very hard Brexit only a year ago. If the EU sticks to its guns, that surely means a less satisfactory trading position for UK companies than before, particularly in the financial sector. Unicredit takes a different view from Deutsche suggesting that

The Conservatives would very likely significantly increase their majority of seats and strengthen their negotiating position for a “hard” Brexit

Indeed, some opinion polls have the Conservatives 20 points ahead of opposition Labour. This surely is the real motivation for the early election; chances to crush your opponents do not come that often. Under its Eurosceptic leader, Jeremy Corbyn, Labour has been ineffective on the Brexit issue. Speaking on the Today programme this morning, John McDonnell, the shadow chancellor, outlines a position that seemed very similar to that of Mrs May; he wants access to the single market, not membership, managed migration, not free movement and so on. He suggested a proposal for a salary cap via a ratio of bosses’ pay to employees’ pay that makes little sense. How would it be enforced? Differential tax rates for different people? What happens if companies simply outsource their lowest-paid jobs? 

Labour is deemed to be so hopeless that the Conservatives are 1/12 with many bookies to win the election; you have to bet £12 to gain £1 if Mrs May is re-elected. But it is worth remembering that the same bookies had Remain as a 1/12 bet on the morning of the Brexit referendum.

Things could go wrong. Voters have been through the 2014 Scottish independence poll, the 2015 election and last year’s Brexit vote; they may be weary of another election and resent the prime minister for calling it (see the reaction of Brenda from Bristol, a voter who went viral after Mrs May’s announcement).

Lib Dems may gain votes and seats from the 48% of the public that voted Remain and is otherwise unrepresented. Labour may manage to move the campaign onto issues such as austerity and the National Health Service, where the Tory appeal is weaker. There is always the risk of bad news; a scandal over expenses in the last election is still rumbling along. Indeed, the current electoral system does not make it easy for the Conservatives to gain seats; in the 2015 election, they were 6.5 percentage points ahead of Labour but only had a 12-seat majority. There are only 21 seats where the Opposition majority is under five percentage points.

While it is hard to see anything but a Tory win, there is a chance that the majority may be 40 or 50: not enough to see off the backbench rebels. The equity market was not as buoyant as sterling; the FTSE 100 suffered its worst one-day loss since last June. Its multinationals are hit by a stronger pound but even the more domestically-focused FTSE 250 is no higher than it was before the election announcement. Equity investors may realise there are lot of Brexit-related risks ahead. 
 
 
The Economist
  

 

 

 

 
  
26.04.2017
 
 
 

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