Ebury: UK General Election Preview
The election is shaping up to be one of the most critical moments in the entire Brexit process and is certain to have a significant impact on currency markets. Following the decision of UK politicians to vote against the timetable for debating the PM’s Brexit Withdrawal Agreement Bill in October, we think that the election is a de facto vote on Boris Johnson’s revised Brexit deal.
Johnson’s Conservative Party continues to boast a very healthy advantage in the latest opinion surveys and has consistently posted double-digit leads over Jeremy Corbyn’s Labour Party in the past few weeks (Figure 1).
A poll of polls since MPs voted in favour of holding an election on 30th October suggests that the Tories could be set to obtain approximately 41% of the overall vote, a lead of around 11% over Labour. Historically, anything in excess of a 10% lead in the overall vote has been more than enough for the largest party to secure a majority in the House of Commons. For context, Theresa May fell only eight seats short of the magic 326 required for a majority at the 2017 election, despite obtaining just 2.4% more votes than Labour.
YouGov’s MRP (Multilevel Regression and Post-stratification) model is predicting Johnson’s Tory Party to achieve a large majority this time around. The model, which uses regional surveys to estimate the most likely outcome of each constituency, suggests that the Conservatives are on course to obtain 359 seats. This would be a clear step up from the 317 the party achieved last time out and would mark the largest majority the party has achieved since Margaret Thatcher’s second re-election back in 1987. The model is seen as one of the most comprehensive of its kind in the UK, having accurately predicted a hung parliament prior to the 2017 vote when most of the polls had indicated a Tory majority.
With almost all of the latest opinion polls and surveys pointing to a comfortable Tory victory, investors have become increasingly confident that a resolution to Brexit, and avoidance of the worst-case ‘no deal’ scenario, is on the horizon. Sterling is currently trading around its highest level in seven months against the US dollar and its strongest position versus the euro since May 2017 (Figure 2).\
We look at the implied probabilities based on bookmaker odds for political events, which usually provide a fairly decent barometer as to what the market is pricing in. This currently gives Johnson’s party around a 95% chance of obtaining the most seats and a 70% chance of achieving a majority (Figure 3). A similar measure from online prediction website PredictIt is slightly less bullish on the Tories’ hopes, although still gives them around an 80% shot at victory compared to the one-in-five probability it assigns to Labour. It is worth noting, however, that the Labour Party has historically outperformed on election day compared to the opinion polls, as they did at the 2017 vote.
A majority victory for the Conservative Party is our base case scenario. In our view, this would all but guarantee that the UK government votes in favour of Johnson’s withdrawal agreement at some point before the 31st January Article 50 deadline. Johnson has stated that he would call for a vote in the House of Commons before Christmas should he obtain a majority. Under such a scenario, we would likely see a rally in GBP, although the lack of reaction in the currency to YouGov’s MRP model suggests that this is already mostly priced in. Under a scenario in which the Tories fail to achieve a majority but secure enough seats to form a coalition government (potentially with the DUP), we think that the withdrawal agreement would likely still pass. This, we believe, should keep sterling well supported around current levels.
We think that the formation of a Labour majority government is highly unlikely at this stage. The focus among investors in the immediate-term would probably be on the party’s perceived less market-friendly campaign pledges, i.e. tax hikes, massive spending increases, higher borrowing and nationalisation. For a country that already has a sizable current account deficit, the threat of higher spending would, in our view, trigger an immediate sell-off in the pound. Should a labour-led coalition, possibly with the SNP and/or Lib Dems, emerge as the most likely outcome following the vote, we think that sterling would also sell-off in the short-term, albeit to a lesser degree given the watered down policy changes that they would be able to implement. As we have mentioned in the past few weeks we do, however, think that the calling of a second EU referendum further down the line would allow for a pretty sharp rebound in sterling, given that this would effectively present a 50/50 chance that the UK remains in the bloc after all.
We outline below the four main election scenarios we now believe are possible, the probabilities we assign to each and the GBP levels that we think each outcome could trigger in the immediate aftermath of the vote.
Polls will be open in the UK between 7:00 AM to 10:00 PM GMT (8 AM-11 PM CET) on Thursday 12th December. Historically, the bulk of the results have tended to begin filtering through from around 2:00 AM on Friday morning, with some semblance of a final result around mid-morning. We may not have to wait that long this time around should the reporting times for this month’s election follow a similar trend to 2017 - many of the swing seats that the Tories have targeted this year were announced early on in the night two-and-a-half years ago.
We therefore expect most of the volatility in the pound to take place during Asian trading, between the hours of approximately 1:00 AM-6:00 AM GMT.