UK election: market and macro implications

The UK’s third general election in less than five years is finally over. And we now know that Boris Johnson’s gamble has paid off: the prime minister’s Conservative party has won its biggest majority since the 1980s, with which it can pursue its Brexit strategy.

What does this mean for the macro outlook?

The outcome of the snap vote dramatically increases the chances that the current exit deal will be approved over the coming weeks. As a result, the UK economy is likely to enjoy a short-term bounce – although a return to the levels of growth seen in 2013-2014 looks unlikely.

For 2020, the election result all but removes the chances of second referendums on EU membership and Scottish independence. The clamour for the latter, however, is only likely to grow in the coming months in light of the strong performance by the SNP.

And significant questions still remain as to the next stages of the Brexit process, not least the timeline for agreement on a ‘future relationship’ with the UK’s European partners. Indeed, given the relatively brief amount of time left for these talks, we expect the new UK government to request an extension to the transition period beyond the end of 2020.

What does this mean for markets?

Before drilling down to UK asset classes, we should point out that despite a probable near-term improvement in investor and business sentiment, we do not expect the Bank of England (BoE) to move interest rates in either direction next year. This is due to below-target inflation as well as lingering concerns as to the trajectory of the UK and global economies.

Markets are moving quickly in the wake of the result, and they will take a while to settle down. But we would make the following observations on UK assets:

• Sterling: We expect the pound to grind higher, though most of the move we expected occurred when the exit poll was released last night
• Gilts: We see global factors as more likely to dominate the UK government bond market
• Equities: We anticipate that domestic UK stocks will probably outperform in the short term, driven by the improvement in sentiment
• Looking further ahead we would expect international investors to return to UK equities as the political-risk premium diminishes
• Credit: Sterling investment-grade credit spreads are likely to compress a little further, in our view

Looking beyond the UK, the clarity delivered by the vote may even elicit a small sigh of relief from EU political leaders and the European Central Bank. We anticipate that Eurozone risk assets will enjoy a minor fillip from the result, too, which helps to lift at least one cloud over the euro area economy (we see a 30% chance of the currency union slipping into recession next year).

It is also probably worth stressing that for the aggregate risk in most of our multi-asset portfolios, the news on a US-China trade deal last night is likely to be just as important as the election. European markets have opened up 1.5% higher this morning – that has got much more to do with Donald Trump and Xi Jinping than Boris Johnson and Jeremy Corbyn.

Long-term themes

Against this backdrop, we remain keenly focused on managing risk to achieve our clients’ long-term objectives.

And as a function of this approach, we recognise that the roots of this vote and the broader Brexit drama lie in deep technological, demographic and political trends. The election campaign has also been reflective of those trends; for example, the pivotal role played by social media.

This is why at LGIM, we focus on addressing the challenges presented by these long-term themes – which will have material implications for the way companies, sectors and even countries evolve – in addition to positioning for more immediate developments.

We should also point out finally that the election sets the stage for a year in which investors will be required to contend with a lot of change, from geopolitics to macroeconomics and markets; for more on what to expect, read our 2020 CIO outlook.