LGIM: UK election – market and macro implications

LGIM: UK election – market and macro implications

Brexit Politics UK

By Sonja Laud, CIO & Hetal Mehta, Senior European Economist

Finally, we have received some certainty over the Brexit process – at least over the near term. We look at what this means for investors. 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.

Hetal Mehta, Senior European Economist at LGIM: 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 reduces 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.

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.

Sonja Laud, CIO at LGIM: 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). 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.

Chris Jeffery, Head of Rates and Inflation at Legal & General Investment Management (LGIM):

“The gilt market is set to open weaker on the morning after the night before. But, it’s worth stressing that the news on the US-China trade deal last night is just as important as the election in driving gilt yields. Donald Trump and Xi Jinping probably have more impact on the pricing of UK debt than Boris Johnson and Jeremy Corbyn. The biggest impact of the election is likely to be seen in the performance of inflation-linked securities. Given the rally in the pound, and the removal of the risk of a fiscal splurge under Labour, we expect a sharp fall in UK breakeven inflation as the day unfolds”