Brexit Update: Who wins a UK general election?

Against the backdrop of a more hardline Brexit strategy from the Conservative Party, this note takes a step back to provide a scenario analysis of the likely outcomes from a next general election that could arise from this more aggressive stance. Additionally, we have updated our Brexit scenarios to reflect the heightened risk of ‘no deal’ following Boris Johnson’s increasingly uncompromising rhetoric and the relative quiet of pro-Remain MPs in the party. Johnson’s initial steps as PM, his ability to build a hard Brexit coalition within his party and the broader parliament, and the response of the EU to the Conservative Party’s hardening stance, will be crucial to determining whether that risk rises further. Many thanks again to the representatives from FX strategy, rates, credit and equities for their input on the market impact assessment.

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General election scenario view

  • In a snap general election, the more fractured UK political system will make it difficult for either the Conservative Party or Labour Party to emerge with an outright majority. Brexit will be the key issue of the campaign, so we expect any cross-party government or confidence and supply agreement to align on the basis of a pro-Brexit or pro-Remain stance. These uneasy ‘coalitions’ are likely to be unstable in the long run but would mainly exist to deliver a Brexit solution.
  • Current polling (average national polling sources) suggests that either a pro-Remain (Labour, Lib Dems, SNP and Greens) or pro-Leave (Conservatives, Brexit Party, DUP) government is similarly likely. However, attributing national vote shares to seat outcomes is difficult in the UK’s first-past-the-post system, while polling biases present another challenge. A key unknown is how individual constituencies would swing in the current environment, where there are almost 100 marginal seats (seats won by 5% or less) and there will be significant tactical voting.
  • In some ways, the Brexit government is an easier one to construct as there are really only two major parties involved. However, in the absence of coordination in the run up, they risk splitting their votes in pro-Leave seats. A Leave government would see a hard Brexit pushed through, resulting in major market sell-off and economic disruption.
  • For the Remain government, the politics are more complicated because it would likely include at least three parties. The SNP would be crucial and likely to demand a discussion on Scottish independence in exchange for support. However, in spite of the complicated politics, this is the best economic and market outcome as it would significantly reduce the tail risk of a ‘no-deal’ Brexit, while avoiding the domestic policy uncertainty that would arise from a Labour majority.
  • A Conservative majority government is more likely than a Labour majority government. The Labour Party is facing challenges regarding anti-Semitism, as well as ongoing weakness in Scotland, which had been a stronghold for Labour in the past. Additionally, the fact that the Conservatives lost support suddenly to the Brexit Party makes it possible for them to recuperate that support again, given the new and untested nature of the Brexit Party’s ground game.
  • A hung parliament is not an equilibrium outcome; rather it would either trigger an election rerun or a temporary unity government to deliver a second referendum. Both would see continued uncertainty for an extended period, weighing on UK assets and economic growth but avoiding the cliff edge for the time being.
  • UK assets are likely to be on a rocky journey before and after a snap election. In particular, our portfolio managers highlighted that initial market impacts in the ‘no-deal’ scenarios (Conservative government, Brexit government) are likely to retrench partially as policymakers give succour in the days following the result. However, they expect any relief to be temporary and to reverse in the months that follow, as ‘no-deal’ reality bites and potential temporary extensions end.

Key assumptions underlying these scenarios

  • The snap election is announced before 31 October to prevent the ‘no-deal’ outcome. It therefore takes place without a Brexit deal in place and is dominated by competing views of Brexit.
  • Johnson is leader of the Conservative Party. Although not yet official, Johnson’s polling in the leadership election has been far stronger than his opponent Hunt. As such, we assume Johnson is leader in these elections.
  • The Conservative Party adopts a harder pro-Brexit stance and Labour a more pro-Remain stance. This reflects a growing polarisation of Brexit views among voters.
  • Corbyn is leader of the Labour Party. Although there are rumours circulating about ill health and substantial pressure from the Labour Party’s anti-Semitism scandal, Corbyn’s position remains solid for now.

General Election Scenarios

table 1

*Hung Parliament is not a sustainable equilibrium and will either result in election rerun or temporary unity government to hold second referendum

**Separate Labour government scenario analysis is available for iterations of Labour governments and their market impacts

(Source: ASIRI, as of 17th July 2019)

Brexit scenarios view

  • A general election remains the most realistic path to circumvent ‘no-deal’ risk in parliament. However, a number of previously pro-Remain MPs now appear to be backing Boris Johnson e.g. Amber Rudd. This suggests that opposition to ‘no deal’ may be waning. In particular, we are concerned about a normalisation of ‘no-deal’ Brexit whereby Johnson and others make it seems like a reasonable outcome, so opposition is weakened.
  • We flagged in our last note that polling suggests it is not the ideal time for either Conservatives or Labour to go into general election, so MPs may be weighing their jobs higher than their Brexit preference. However, September will be the crucial test as MPs will be faced with the reality of the new government and the potential risk of ‘no deal’. Investors must watch this period closely.
  • In the meantime, Johnson’s latest comments ruling out the backstop in any form has further underlined his hardline approach. This may be a negotiating tactic to put more pressure on the EU to offer concessions. However, on the EU side, views only appear to be hardening and so the risk that this game of chicken ends badly has risen. Moreover, even if the EU offered concessions, Johnson has painted himself into a corner such that acceptance of compromise risks a backlash from hard Brexit MPs and a loss of support to the Brexit Party.
  • It is very difficult to assess the outlook at the current juncture because Johnson is still in campaign mode, vying for the hardline Brexiteer members vote. We will reassess these probabilities in late August/early September when there is more evidence of his position and the reactions of MPs. In the meantime, we are taking a precautionary approach, increasing the risk of ‘no deal’ to the second most likely outcome by 31 October with approx. 25%-30% probability.

Next Step Brexit Scenarios

table 2

(Source: ASIRI, as of 17th July 2019)

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The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.