Surprise snap election rocks UK risk profile

Mayday: Theresa May's election announcement has given some investors that sinking feeling

The UK prime minister made the surprising announcement just after the Easter break that she would call a snap general election for June 8, three years before her term is complete according to the five-year parliamentary cycle.

The election was approved by the two-thirds majority required to override the Fixed-term Parliaments Act of 2011, which many suspect will now be dispensed with.

The elections are to be held after partial nationwide elections for local councils and mayors on May 4, and will be based on existing parliamentary constituency boundaries the government was planning to reform, which means the main opposition Labour Party retaining its slight advantage in smaller urban areas.

Nick Kounis, of ABN Amro, believes an early election increases political risk.

“A larger proportion of the 48% of the electorate that voted to remain in the EU may rally around the Liberal Democrats, calling for a second referendum.

“To the extent that these supporters are drawn from the Conservative ranks, this could eat away at the Conservative majority. The risk scenario is if the Conservatives lose their majority, plunging the UK into political chaos during the Brexit negotiations, which would then be delayed.”

The latest opinion polling predicts a landslide victory for the Conservative Party, which presently has 330 of the 650 seats, and a 17-member working majority.

The lead is as much as 21 points over Labour, as confidence in May’s ability to secure Brexit has increased, and despondency over Labour’s militant-left leader Jeremy Corbyn continues.

That could deliver a three-figure majority in the House of Commons (the lower house), although it is expected to be smaller given the predicted comeback for the Liberal Democrats, the dominance of the Scottish National Party (SNP) north of the border, and the possibility of some pushback from Labour.

One opinion poll shows the Conservatives with only a nine-point lead, and pollsters had a poor record in predicting Brexit. May’s confidence might therefore be vastly exaggerated.

The UK was the only G10 member to experience rising risk in Q1 2017, as economists and other experts taking part in Euromoney’s country risk survey downgraded their scores largely based on the uncertainty of the Brexit trade talks.

The UK slipped to 21st in the global rankings, within the second of Euromoney’s five tiered categories:

Government stability risk was higher on a year-on-year basis, with experts factoring in the possibility of an early election despite May seemingly ruling one out after the Brexit vote.

All other political risk factors were downgraded, notably institutional risk and the regulatory and policymaking environment, reflecting the problems anticipated with Brexit.

Economic risk factor scores were also lower too, especially with inflation rising.

Holding an election early avoids staging one under transitional arrangements with the EU, as the timeframe for Brexit has lengthened, with talks unlikely to begin until after the elections in Germany in September.

A larger government majority hands May a mandate, and lowers the risk of opponents stalling a deal.

Philip Rush, from Heteronomics, says: “In some commentators’ opinions will be the risk that the Conservatives pursue a harder Brexit with an enlarged majority, but I doubt that will make much difference to the negotiating position.”

Ebrahim Rahbari, of Citi Research, adds: “The expectation of a stronger Conservative majority post-June somewhat decreases the chance of a chaotic Brexit.”

However, as Danske Bank’s Mikael Olai Milhoj writes: “Our base case remains that May will stay in power and negotiate a decent Brexit (neither too hard nor too soft), but the probability of other outcomes has clearly risen with [Tuesday’s] election call.”

Just as importantly, the Conservatives can pursue a new agenda backed by a solid majority.

Speculation suggests it might involve lowering the foreign aid budget, which is currently set at 0.7% of gross national income.

The triple-lock on pension payments would be amended, along with the migration target, and the government could go ahead and increase tax rates on the self-employed, all of which would free-up more resources to plug the gap in social care and prioritize education to ease public concern without inflicting any fiscal damage.

The UK’s economic outlook moreover is not as gloomy as the one depicted by Project Fear in the run-up to the Brexit referendum in June.

Only this week the IMF upgraded its GDP forecasts, showing 2% growth this year with a narrowing current-account deficit and stable, low unemployment.

On the other hand, new problems emerge, not least the fact Chancellor Philip Hammond seems determined to let the fiscal targets slip.

Plus, a stronger pound sterling makes it more difficult for exporters.

The IMF is already anticipating slower growth of 1.5% for 2018, with inflation rising further (to 2.6%) and the unemployment rate turning upwards.

And then there is still the problem of not really knowing what deal the EU and the UK can strike.