How will markets react to different election results?

The tightening of polls in the lead-up to the election has made a consideration of what would happen under each potential scenario more important. A Conservative victory is the most likely outcome but a hung parliament and even a win for the Labour party are both entirely feasible. Uncertainty about the result has seen gains in GBPUSD capped near 1.30 and the FTSE 100 break to new highs above 7,500 and its best monthly return this year.

A Conservative majority

A landslide Conservative Party victory seems less likely now, so it would be a positive surprise. The reaction in currency markets to election polls during the campaign suggest a landslide Tory win would be a clear Sterling-positive result. A small conservative majority is probably the base-case scenario for the market. Keeping the status quo is a good thing for certainty but if Theresa May doesn’t achieve her goal of a bigger mandate for Brexit, that’s creates uncertainty.

The Tories winning the general election in 2015 caused a positive reaction in the FTSE 100 but Brexit could mean a different reaction this time. The devaluation of the pound since Brexit has boosted the FTSE so any rise in the pound after the election will be a negative influence. In addition, a hung parliament was expected in 2015 so a win was a surprise.

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The traditional assumption of market-friendly Conservative Party policies would be a positive factor for the FTSE. The Conservative Party is based on the principles of lower taxes, less government spending and controlling the national debt. Theresa May appears more interventionist than previous PM David Cameron but Jeremy Corbyn is also perceived as more anti-business than previous opposition leader Ed Miliband.

The going assumption is that a bigger majority could allow Theresa May to soften her approach to Brexit because she would rely less on the support of hard-line EU-sceptics. However there would be less chance of a parliamentary vote at the end of the Brexit negotiations overturning a ‘Hard Brexit’ deal.

If a Conservative victory brings about a stronger pound, perhaps GBPUSD moving toward 1.4, then that would be on-balance positive for domestically-focused retailer and homebuilder shares but negative for multinationals reliant on foreign earnings like Burberry as well as miners and banks.

A hung parliament

In many ways a hung parliament is the least market-friendly result because it creates uncertainty and could be the biggest delay to the start of Brexit negotiations. Brexit negotiations are due to start in June, right after the election.

The Conservatives would most likely have the first stab at creating a coalition but it would fall to Labour if they couldn’t. The Liberal Democrats leader Tim Farron has ruled out a coalition with May’s Conservatives or Corbyn’s Labour. We suspect Farron’s Lib Dems could be tempted into a coalition with Labour if a second Brexit referendum is promised. The mostly likely coalition would be between Labour and the Scottish National Party, the so-called ‘coalition of chaos’. The Scottish National Party has been very pro-EU but still want A second Scottish referendum (Indyref 2). It’s not clear whether Scots will vote according to their desire for Scottish independence or UK independence from the EU.

The hung parliament could be the only scenario in which a clouded outlook for Brexit and the economy means both the pound and the FTSE fall together. There’s an argument to be had that a ‘softer Brexit’ under a left-of-centre coalition would be positive for the British pound over the medium term. We don’t buy that. Aggressive posturing from Europe would suggest a ‘Soft Brexit’ whereby concessions on immigration can be met with concessions on the single market is basically impossible whichever UK political party is involved.

Utility firms are in a difficult spot because both major parties have made proposals to intervene to reduce energy bills, so potential for inaction under a coalition might be the best hope.

A Labour majority

As unreliable as polls have been, a Labour Party landslide seems very unlikely. Opposition leader Jeremy Corbyn has brought some of his critics on-board with a manifesto that gives voters a clear choice between the main political parties. We think Jeremy Corbyn would stay on as Labour leader no matter the result.

We assume a Labour victory would be Sterling-negative – perhaps GBPUSD back towards 1.25. However we don’t see any huge fallout. Labour tend to favour higher taxes on the wealthy and higher spending on public services, attaching less importance to the national debt. Higher spending under Labour would be positive for economic growth in the near term, though could bring about a sovereign debt downgrade from ratings agencies.

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The Conservatives and Labour both have a pretty similar policy with respect to Brexit – both voted in favour of triggering article 50. If anything, there is a marginally higher chance that predominantly Remain-supporting Labour MPs try for a second referendum. That said, Labour should recognise that a lot of its base supports Brexit and realistically wouldn’t be able to handle negotiations any differently than the Conservatives.

What are the other driving forces?

The British pound trades against foreign policies and the FTSE 100 lists multinational companies so the UK election cannot be viewed in a vacuum. There are other global factors that the UK election will either diminish of exacerbate. Political uncertainty is no restricted to the UK; There are new Presidents in the US and France and parliamentary elections later this year for Germany and potentially Italy.

Voting takes place on June 8th. Polling stations close at 10pm in the UK. The result usually becomes clear by 3am but exit polls could give an indication as early as midnight – especially if it’s a landslide.

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