Britain’s political chaos sees snap election slipping onto traders’ radars

(Bloomberg) —

The nonchalance of the British markets in the face of the ousting of Prime Minister Boris Johnson could change in the blink of an eye.

Johnson’s ouster has boosted the chances of a snap general election, according to market strategists from NatWest Markets, Citigroup Inc. and Mizuho International Plc. This opens the door to a spending spree to woo voters before they go to the polls, followed by the possibility of the opposition Labor Party coming to power and spending more money.

It would impact everything from the Bank of England’s politics and taxation to the pound, bonds and stock markets – and would also see earlier risks resurface, such as another vote on the independence of the UK. Scotland and the reopening of Brexit negotiations. While there are still plenty of ifs and buts, an election is already filtering into the mindset of investors.

“The prospect of the election itself would be unambiguously negative for the currency as broader political risk escalates,” NatWest analysts including Imogen Bachra said. “An early election and therefore greater than expected fiscal easing raises the risks that the BOE will act more ‘forcefully’ in the second half of 2023 and that longer-term gilt yields will rise.”

After three tumultuous years in office, Johnson’s reign appears to have come to a chaotic end after members of his government resigned en masse last week. His Conservative party is urgently drawing up plans for a fast-track contest to choose his successor this summer.

Chaos-weary Tories can now put a pair of safe hands in No 10

The next election is not due until January 2025 at the latest, and Johnson’s successor will not be forced to return to the polls any sooner. Nonetheless, they might be tempted to capitalize on any political honeymoon in the early months of office in hopes of locking in another five years of power and public legitimacy.

This outlook has already led the NatWest team to change its BOE forecast, expecting faster interest rate hikes and a slower bond-selling program given the prospect of a increase in public spending. They revised up their year-end 10-year gilt yield target to 2.25%.

Yields have already surged to end last week near this level. The leadership race is in full swing, with former Chancellor Rishi Sunak announcing his candidacy on Friday.

The race to succeed Boris Johnson starts as Sunak makes his way

“Nobody knows yet who the Chancellor will be and what his approach to fiscal policy will be: will they tighten it, loosen it, worry more about winning back electoral support via tax cuts and handouts?” said Stuart Cole, chief macroeconomist at Equiti Capital, adding that he would not be surprised by an election in 2023.

The picture for the pound, already down around 11% this year, is more complicated. While loosening the government’s purse strings or cutting taxes could boost Britain’s economy, it could also push up inflation and put public finances under pressure. The new leadership will also bring other market-sensitive policy changes.

UK budget watchdog challenges Tory tax cut ambitions

For the UK stock market, companies focused on the domestic market would likely get a boost if a new leader raises question marks over the planned rise in corporation tax next year. Britain’s midcap FTSE 250 benchmark has fallen around 20% in 2022.

More aggressive BOE rate hikes and a stronger pound could prove negative for the FTSE 100, where around 75% of corporate sales are made overseas. Higher borrowing costs would also hurt consumers and therefore retail stocks like Next Plc and Marks & Spencer Group Plc.

“The political uncertainty comes at a time when sentiment towards UK equities is already lackluster – this is reflected in many cases in UK corporate valuations lower than their overseas counterparts as well as recent weak net flow data. for UK equities,” said Gabriele Foa, portfolio manager at Algebris Investments.

While rate hikes would widen the profit margins of lenders such as Lloyds Banking Group Plc and NatWest, UK banking stocks could remain under pressure as the country faces a recession. Investors in utilities and oil companies such as Centrica Plc and Shell Plc will be watching closely for pressure to raise taxes on the sector to reduce energy bills.

In terms of broader commercial and political risks, some analysts point to the potential for improved relations with the European Union. Johnson had proposed legislation that would give Britain the option to unilaterally change its post-Brexit settlement for Northern Ireland, risking a trade war with the bloc. On the other hand, a new election could remove the existential risk of Scotland’s break with the UK, given Tory opposition to an independence referendum.

“We see the change in direction as a marginal benefit for the pound via an increased likelihood of fiscal support and, in the medium term, a lower bar for better relations with the EU,” said Shreyas Gopal, strategist at Deutsche. Bank AG. However, any leadership candidate “who shows a willingness to go to the polls will be seen as the most negative for the pound, given the additional uncertainty this would introduce”.

At present, there are so many potential candidates that it is difficult to gauge the opinion of the winner. Some analysts are skeptical that a new leader is likely to go to the polls, since the Conservatives still have a large majority in Parliament. Given the dire economic situation Johnson’s successor will inherit, that would be a big risk.

The recent history of the success of such a strategy has been mixed. Former prime minister Gordon Brown squandered the opportunity to be forced out of power in 2010. Theresa May’s snap election in 2017 ended up costing her a majority, although Johnson himself was more successful in 2019 .

“A new leader would surely want a term, but it would be nearly impossible to achieve a majority close to what Boris Johnson got in 2019,” said Geoff Yu, senior currency strategist at Bank of New York Mellon. “An election could lead to months or weeks at least of political gridlock, so that just wouldn’t be helpful.”

This week

  • Anticipated speeches by European Central Bank officials, including Joachim Nagel and Francois Villeroy, could provide monetary policy clues to investors ahead of the central bank’s self-imposed period of calm ahead of the upcoming July 21 decision.
  • Germany’s ZEW data for July is the culmination of a relatively subdued week for economic releases. UK GDP data for May set to stabilize after two months of contraction
  • Bond sales from Germany, Italy and the Netherlands are expected to total around 17 billion euros ($17.3 billion) according to Citigroup Inc. Danske Bank A/S expects a European offer in two tranches via banks, including a new 10-year benchmark bond. UK sells £2.75bn of 10-year debt

©2022 Bloomberg LP

About Rodney Fletcher

Check Also

This pharmaceutical company is growing – Here’s how to invest

LLast week, Danish pharmaceutical company Novo Nordisk announced that its first quarter earnings beat estimates, …