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Same-Day Analysis

Hung parliament likely to delay UK's Brexit negotiations, policy-making likely to become difficult

Published: 6/9/2017

Following the early general election yesterday (8 June), the United Kingdom is likely to be governed by a minority centre-right Conservative Party administration, under the leadership of incumbent prime minister Theresa May or her replacement as Conservative leader.



IHS Markit perspective

Outlook and implications

  • The United Kingdom is likely to be governed by a centre-right Conservative Party minority government, either under incumbent prime minister Theresa May or her replacement as Conservative leader.
  • A weak and potentially unstable UK government increases the risk of slow progress in EU Brexit negotiations.
  • The result heightens the risk of another general election before the end of the upcoming five-year administrative term, despite formal commitments that UK parliaments should serve their full period.

Risks

Policy instability; Government instability

Sectors or assets

All

UK prime minister Theresa May on stage at the Magnet Leisure Centre in Maidenhead, after she held her seat, 9 June 2017.

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The centre-right Conservative Party led by UK prime minister Theresa May yesterday (8 June) came first in the early general election, winning 318 seats in the House of Commons (lower house of parliament), with one seat still pending. However, the Conservative Party lost 12 seats vis-à-vis the 2015 general election and fell short of the overall threshold of 326 out of 650 seats needed to achieve an overall majority.

The Conservatives formally need the support of another party to form a coalition or, more likely, to back a minority government, but will be helped by Sinn Féin’s possible absence from Westminster, potentially leaving their seven seats unoccupied. Northern Ireland’s Democratic Unionist Party (DUP), which is similarly socially conservative and pro-Brexit in orientation, is the only realistic contender to offer stable support to the Conservatives.

The centre-left Labour Party managed to extend its parliamentary representation by 29 seats, coming second with 261 seats overall. The Scottish National Party (SNP) lost 1.7% of its 8.6% share of the vote in 2015, which led to it falling from 56 to 35 seats, remaining in third place. The pro-EU centrist Liberal Democrats (Lib Dems) won just 12 seats and the pro-Brexit United Kingdom Independence Party (UKIP) lost 10.8% of the 12.7% electoral share it had held in 2015, gaining no parliamentary representation.

Overall, the Labour Party succeeded in gaining an extra 9.5% of the share of the vote versus 2015, narrowing the gap versus the Conservatives to a 42.4–40.0% margin. Despite the much closer outcome, the Conservatives also gained a higher share of the vote, up 5.5% compared with 2015, particularly reflecting UKIP's collapse.

Minority Conservative Party government reflects campaign failings and terrorist events

Following May’s announcement on 18 April that she was calling an early election, the Conservative Party initially topped most opinion polls with margins of up to 16%, indicating a likely parliamentary majority of more than 100 seats. However, her campaign suffered multiple mishaps and policy U-turns over issues such as social care, while it was also hurt by the likely opposition of many Conservative voters to a hard Brexit. Following three terrorist attacks in the UK claimed by the Islamic State in less than three months, including two during the campaign, with indications of security monitoring failures, May also had to face severe criticism over her decision to cut nearly 20,000 police jobs when serving as home secretary.

Increased policy instability likely, including Brexit

The new government’s room for manoeuvre in legislative procedures will be limited during the new administrative term and May or her successor will have to avoid major intra-party discord in order to form working majorities in parliament. Although issues such as security, labour-market reforms, social and health care, and education are unlikely to prove overly divisive within the Conservative Party, it is highly likely that policy instability will be heightened regarding Brexit. The Conservative Party is likely to remain divided between the options of a "hard" or a "softer" Brexit, with strongly held views on both sides. This may force the government to seek opposition support for it to be able to implement policies on Brexit.

With regards to the economy, UK 10-year government bond yields initially jumped from 1.0% to 1.06% following the election, but have since traded back to 1.02%, towards the lower end of their trading range over the past month. Sterling has been more severely damaged, falling from GBP1.00:USD1.295 yesterday to a low of GBP1.00:USD1.265; it now stands at GBP1.00:USD1.274. Although this is a sharp fall, it should be noted that sterling traded as low as GBP1.00:USD1.204 on 17 January, and was around GBP1.00:USD1.21 in early March. Against the euro, it is currently around GBP1.00:EUR1.14, versus a 15 January low of GBP1.00:EUR1.134. The FTSE 100 index is up 0.6% on the day. None of these developments indicate major market change. After multiple rounds of opinion polls showing a loss of Conservative support, and May’s rather poor campaign, the markets seem to be viewing the results as broadly discounted.

Economic implications

The indecisive UK election result presents an additional threat to an economy already displaying diminishing resilience to the initial Brexit shock. Prolonged political turmoil would represent another blow to already flagging economic sentiment. Consumer confidence is sliding, and the election outcome is an unwelcome distraction for households facing higher inflation and muted earnings growth. Meanwhile, business confidence could falter, prompting companies to defer their investment and employment plans until a clearer Brexit path emerges.

Political disruption elevates the downside risks to growth, and IHS Markit will reduce its GDP growth forecasts to 1.5% (from 1.7%) in 2017 and 1.1% (from 1.2%) in 2018 in its June update.

Encouragingly, the lack of electoral appetite for a hard Brexit sits comfortably with our baseline assessment that the UK will extract a free-trade agreement with the EU alongside some industry-specific agreements on access to the single market. Therefore, our medium-term projections remain unchanged, with firmer UK growth projected to return relatively quickly, moving up to 1.5% in 2019 and 1.9% in 2020.

The pound has slipped initially against the major currencies, and is set for a bumpy ride this year. However, the reduced likelihood of a hard Brexit and another Scottish independence referendum supports our assessment that sterling will revive from mid-2018.

Outlook and implications

In the likely event of an unstable Conservative government, there would be a heightened risk of a second general election being called later this year. In addition, Prime Minister Theresa May is already facing pressure from within her party to step down, making a change in leadership more likely. Party sources consulted with by IHS Markit rank Boris Johnson and David Davis among the likely front-runners to replace May.

IHS Markit assesses that the hung parliament is likely to worsen the Brexit-driven slowdown in day-to-day policy-making in the UK parliament. The Conservative government is likely to be unable to effectively implement policies or agree on Brexit strategies unless these can attract unanimous support or a large intra-party majority. The prime minister is likely to face the need for regular and potentially long-winded compromises on policy priorities, at times even relying on opposition support for Brexit-related issues.

The Conservative government's limited power in parliament is likely to delay Brexit negotiations. May or her successor could be forced into a more volatile and unpredictable negotiating strategy because of the difficulties in gaining domestic parliamentary support on contentious issues such as the UK's final EU budget contributions.

Nevertheless, as specified in our economic forecasts, we currently expect that the election is unlikely to change the outlook for the UK’s business environment significantly vis-à-vis the previous administrative term. Brexit-related uncertainty will prevail at least until 2018, with early negotiations between the UK and the EU likely to be hampered by contradicting demands. Particularly contentious issues will include the settlement of final UK contributions to the EU budget and the UK’s goal to obtain as much access to European markets as possible while rejecting free movement of people or the jurisdiction of the European Court of Justice. The election result is unlikely to change the EU’s Brexit strategy or priorities for the first rounds of negotiations significantly. These were due to start on 19 June but could now be delayed, especially if May is forced to resign.

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