Hung Parliament throws leadership into doubt but no panic in markets

With the bulk of votes now counted, it appears that the early exit poll was correct and the Conservatives have not won an outright majority. The Conservatives are expected to have won 43% of the vote with Labour on 40%. Labour has done much better than expected in England, while the Conservatives have done very well in Scotland.

Potential Outcomes:

It is still early days, however, these scenarios are starting to look like the most likely outcomes:

• A second election: At this early stage, the Conservatives could try to form a coalition with Northern Ireland’s DUP, who are projected to get 10 seats. Combined with the 318 seats projected for the Tories, this would give Theresa May a slim majority of two seats. This would be a very fragile coalition during the crucial Brexit negotiations, and it’s questionable how long such a coalition could exist. The prospect of a Progressive Alliance led by Labour and the SNP, with the Lib Dems and Plaid Cymru has also been thrown into doubt because of the Conservatives’ gains in Scotland, at the expense of the SNP. This makes a second election extremely likely at this stage.

• The Prime Minister resigns: At this stage, Theresa May’s future hangs in the balance, and there is a possibility she may not be Prime Minister for too much longer. Betting markets still has Theresa May as PM, with Boris Johnson in second place. However, the BBC is predicting a 50/50 chance that Theresa May will resign later today.

• Brexit negotiations are delayed: Unless a government is formed between now and June 19th when Brexit negotiations are expected to restart, we would expect these crucial negotiations to be delayed indefinitely. This election result could make it even harder to get a deal with the EU in the two-year time limit.

The market reaction:

While the hung parliament result was a shock, the market reaction has also been somewhat puzzling. GBP/USD initially dropped 200 points on the result from 1.2950 to 1.2750, however, as the results have rolled in and confirmed the exit poll result, the pound has remained relatively stable, suggesting that the prospect of a hung parliament and a second vote is not triggering market panic.

Perhaps the market is looking at this result as a vote for a softer Brexit, which could boost the pound in the long run. However, this is fairly presumptuous of the FX market at this early stage. EUR/GBP also spiked higher, but is well short of the pop to 0.90 that some suggested on the back of an unclear election result. Likewise, even though GBP/JPY took an initial beating, it has managed to hold above the key 200-day sma at 138.92.

Sterling still attracting buyers amidst political uncertainty

At this stage of the election results, there are buyers willing to pick up sterling on the dip. I don’t think this is based on hope that the Conservatives will form a coalition with the DUP, which makes a hard Brexit more likely; instead this could be on the back of hope that there will now be a soft Brexit. The British people may have voted to leave the EU last year, but it seems like they want a trade deal and don’t want an exit to hurt the prospects for the economy. Ironically the uncertainty formed by this election result is not causing market panic, even though who governs the UK now hangs in the balance.

The price action in gold priced in GBP, also suggests that the market is not in panic mode. Although GBP/XAU spiked on the exit poll, it has since given back these gains. The FTSE 100 futures market is also predicting a small loss for the UK index; however, the early decline in sterling could benefit the FTSE 100 later today.

So what is next?

We would argue that at this stage, political uncertainty is high and the market reaction is hard to predict. Will the markets be so calm if Theresa May resigns later today? Will the markets remain so calm if it looks like it will be tricky for either the Conservatives or Labour to form a coalition government and another election looks likely?

Look out for our next report to see if we can answer any of these questions.

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