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UK Elections on 8th June - A key step ahead of Brexit

 

The essential

  • Early UK elections will take place on 8th June.
  • These elections were meant to increase the Tory majority in Parliament as well as the legitimacy of PM Theresa May so that she could negotiate Brexit procedures more effectively.
  • But May’s gamble seems more difficult to win now. While the polls (which were not reliable in the last major UK votes) show the Conservatives still in the lead, that lead has significantly narrowed over the past few weeks.
  • The winner will also have to manage the UK economy’s deceleration, perceptible since the year began.
  • If she gains a well extended majority, May will be able to implement her Brexit strategy: a hard line in the beginning, probably followed by necessary concessions. Exiting without an agreement is scarcely an option.
  • Another (and very plausible) scenario is a re-elected but reduced (or barely extended) Conservative majority, increasing the risk of more conflictual Brexit negotiations.
  • Conversely, a minority or coalition government (with or without the Conservatives) would probably move the UK position toward a “softer” Brexit (though with varying possibilities, and some caveats).

SPECIAL WEBCONFERENCE – on Friday 9th June 2017

 

By announcing in mid-April that snap elections would be held on 8th  June, UK Prime Minister Theresa May took a gamble that seemed to make sense as difficult Brexit negotiations approached:

  • With Labour greatly weakened (due to the very left-leaning positions of leader Jeremy Corbyn), these early elections give Tories the chance to increase their majority in Parliament. At present, this majority is just 10 seats, or 330 MPs out of a total of 650.
  • A strong outcome to these elections would strengthen May's mandate among both the public and the Conservative Party, giving her more weight to effectively conduct Brexit negotiations with the Europeans. It is important to recall that although May said it was not desirable to reveal all of the United Kingdom's objectives in these negotiations, her government officially favours a “hard Brexit” (a clean break with the single European market). However, she must still marshal her resources to make a few concessions, which means having a strong enough hand to rein in the most anti-European elements in her party
  • Finally, while in principle the United Kingdom is to leave the European Union in March 2019 (two years following the recent triggering of Article 50 of the Treaty of Lisbon), the new framework for economic relations between the country and Europe could very well not be fully stabilised by that time. The UK legislature sits five years, so organising an early election in 2017 pushes the next elections to 2022 instead of 2020, which would give the government more time to finalise Brexit before kicking off a new electoral campaign.

 

In addition to the negotiations over Brexit itself, the future UK government may have to manage an economic deceleration.

  • Contrary to what many observers believed, the UK economy handily absorbed the uncertainty shock over the Brexit victory in the second half of 2016. The pound's sharp depreciation, which bolstered exports and tourism revenues, played an important part in this process.
  • However, there are now signs of a loss in momentum. GDP growth was just 0.2% in Q1, the lowest figure since late 2012. Some indicators, particularly on investment and real estate, have worsened, even as the eurozone's indicators have improved. In addition, imported inflation, tied to the currency's decline, has started to eat into consumer purchasing power. Difficult negotiations with Europe and the increasing likelihood of a hard Brexit could weight even heavier on the business climate.

 

In light of recent poll numbers, May's gamble is not yet won.

  • The Conservatives are still ahead in the polls, but they are down several points since mid-April, falling from nearly 50% of voting intentions to just above 40%, notably after a poorly-received about-face on aid to the elderly. During that time, the number of voters leading toward Labour has risen considerably (from about 25% to more than 35%), tipping the other parties (UKIP, the Liberal Democrats and the Scottish National Party) downward. As to the projected results in terms of seats in Parliament, a few (not most) polls even indicated that the Conservative Party could lose its majority, which would force it to form a coalition government with another party, or even cede power to an alliance of its adversaries.
  • However these indications must be taken with caution: UK polls have not been reliable in the last two major national votes: (1) the 2015 general elections, which gave the Tories the absolute majority where a "hung" Parliament with no majority was expected; (2) the June 2016 referendum, when Brexit carried the day although Bremain seemed the most likely winner.
  • While the Tories are still most likely to retain a majority in Parliament, any failure to significantly increase that majority (in view of what could be expected a few weeks ago) would still be seen as a setback for May, who would fail to strengthen her mandate as hoped.

 

A significant Conservative win (still the central scenario, although probably not the landslide that was initially expected in April) would be followed by an opening of relatively hard Brexit negotiations as currently projected.

  • A win for May (i.e. a clear increase in the Tory majority) would allow her to start Brexit negotiations in keeping with her strategy, probably still hard at the outset but with some allowances later. There already are, and will continue to be, numerous reasons for discord with the Europeans. Disagreements start with the sequence of the negotiations. The Europeans want to first obtain an agreement on the Brexit issues (specifically, expatriates' rights on both sides, and the amount of money being demanded from the United Kingdom to settle all its accounts), and only then to begin negotiations on a future free-trade agreement with the UK. Meanwhile, the British want to tackle these two negotiations head-on. Thereafter, even if the UK's approach prevailed, two years seems like a very short time for negotiating a free trade treaty. Some issues are particularly technical and, although reaching an agreement on trade in goods is probably in the common interest, the sensitive financial services sector could pose multiple problems.
  • As the Article 50 countdown gets into gear, however, May's initial positions (complete exit from the single market, rejection of the free movement of people, preference for no agreement over a "bad" agreement, possible use of the tax lever to increase the UK's appeal in relation to Europe) will become more and more difficult to maintain. Ultimately, concessions on both sides will be vital. Indeed, failure to reach an agreement would mean that only the WTO's trade clauses would be applied, which would raise countless practical problems (it must be stressed that none of the European Union's major trading partners deal with it on the basis of these clauses alone). But these necessary mutual concessions will not be made without some shows of force and periods of tension.
  • Finally, in terms of domestic economic policy, the Conservatives' agenda does fit well within the lines of current policy, with a softened fiscal stance since last year to better buffer the shock of Brexit, tax cuts and a minimum wage hike as had been promised by David Cameron, consumer protection against rises in energy prices, an adjustment (a little less generous) to the public pension indexing mechanism and an increase in housing construction. The Conservative government will also continue to oppose demands for another Scottish independence referendum.

 

If, on the other hand, May loses her gamble, there are several plausible scenarios, with very different consequences for the Brexit process.

  • Alternative scenario 1: the Conservatives keep their majority in Parliament while losing some seats or winning only a few. May's position (if she remains Prime Minister) in negotiating with the Europeans would then be weakened. There could then be a growing risk of a worsening climate for negotiating with the Europeans, as May would have difficulty limiting the influence of the hard-line Eurosceptics in her own camp. That said, even in this configuration, the most likely scenario would still be an agreement—even a minimal one—with the Europeans.
  • Alternative scenario 2: the Conservatives lose their absolute majority and must form a coalition with another party or a minority government. However, an alliance with the Liberal Democrats (the Conservatives’ governing partner prior to 2015) seems unlikely due to the latter’s very pro-European stance (they demand a second referendum on Brexit) and bad experience from the previous coalition. A coalition with the Scottish National Party also seems very difficult for the same reasons. A coalition with Labour would require overcoming not only divergent views on Brexit—Labour wants a softer Brexit—but also strong ideological opposition given Labour's recent move to the left, as it seeks, among other measures, to nationalise certain utility companies. The outcome of such negotiations is quite hard to predict, but most likely there would be an easing of the official hard Brexit strategy, as with a minority Conservative government that would need to strike deals with other parties.
  • Alternative scenario 3: Labour finds itself in a position to govern the country as part of a coalition with the Liberal Democrats, the Scottish nationalists, or both (an absolute majority for Labour is extremely unlikely). Such a scenario (that would also require difficult deals between theses parties) undeniably leans toward a much softer Brexit than that advocated by the Tories. Nonetheless, once in government, the opposition parties would be back in a position, vis-à-vis the Europeans, that is reminiscent of May's situation today: in charge of national interests, which means not being too "tender" early in the negotiating process, and not revealing all of the objectives being pursued. 

 

Conclusion:

May's gamble is not yet won. While not the central scenario, a setback (complete or relative) for the Conservatives could alter the conditions in which Brexit will unfold. Whatever happens, though (even perhaps in the unlikely scenario of a government not led by the Conservatives), difficult negotiations are to be expected, as are temporary episodes of market stress over the prospect of an exit by the UK without an agreement with the EU. Ultimately, we are keeping the view we have held since the referendum of last 29 June largely unchanged. An agreement will be reached, preserving the bulk of the free exchange of goods and just part of the free exchange of services, probably with a compromise on the other contested issues, such as the free movement of people and the UK's contribution to the European budget.

 

Current composition of the UK Parliament:

Conservative: 330

Labour: 232

Scottish National Party: 56

Liberal Democrats: 8

Others: 24

 

Latest poll (%)

Conservative: 42%

Labour: 36%

Scottish National Party: 5%

Liberal Democrat:s 8%

 

 

PERRIER Tristan , CFA, Strategy and Economic Research at Amundi
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UK Elections on 8th June - A key step ahead of Brexit
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