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CIO Flash
Preview U.K. general election – Into the unknown
May 5, 2015
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Current situation
— The United Kingdom will hold a general election on May 7. According to current opinion polls, neither the Conservatives nor Labour is
likely to be able to command an absolute majority of the House of Common’s 650 seats. In that case they will have to attempt to form a
minority government, or engineer a coalition arrangement (formal or informal) with some of the minor parties.
— The Conservatives look on course to emerge from the election with the largest number of seats (perhaps 270-280) and could then try to
govern on its own. Their ability to attract support from other parties may be limited. The Liberal Democrats, the Conservatives’ current
coalition partner, look set to lose a large number of seats and also appear deeply split on who to support. Other potential partners might
be the Democratic Unionists (Northern Ireland) and UKIP but these would be difficult bedfellows.
— Labour currently looks set to gain around 260-270 seats. These, combined with the c. 55 seats expected to be won by the Scottish
National Party (SNP), some Liberal Democrat and other minor party support, might result in a total seat tally above the 326 needed for a
majority. But Labour has ruled out a “deal or coalition” with the SNP if it was needed to form a Labour-led government. This commitment
may be designed to bolster Labour’s support in Scotland, or reassure English voters, or to prepare the ground for an attempt at a
minority Labour government (which the SNP, even if it did not formally support it, might be reluctant to stop).
— While the prospect of a much more fragmented party lands cape and the unproven process of coalition-building leaves markets in a
period of uncertainty, the highest degree of prolonged uncertainty might stem from a majority win of the Conservatives. In that case they
would have to stick to their promise to hold a referendum about Britain’s membership in the EU by end-2017. The prospect of this
referendum – as the British electorate’s appetite for a “Brexit” is unclear – might be negative for markets.
Timeline
— Election results will be released, seat by seat, during the night of May 7/8. Formal negotiations can then start between the parties.
These took six days after the 2010 election. On May 18, parliament reassembles. On May 27, the Queen reads out a summary of the
the new government’s proposed agenda (the Queen’s speech). By then, either the Conservatives or Labour will need to have convinced
the Queen that they can create a viable government. In early June the House of Commons will vote on the Queen’s speech. If the new
government loses this vote, it will not automatically trigger an attempt to form a new government. But the credibility of the new
government would be badly damaged and a vote of confidence could follow soon after.
Investment implications
— It is important to distinguish between three factors:
—
Uncertainty over the composition/stability of the next government. Coalition negotiations could take several weeks and, under a
worst-case scenario, it may not be evident whether the United Kingdom has a viable government until early June or even longer.
Markets might be assumed initially to react negatively to such uncertainty. One question is whether, if the uncertainty is
prolonged, markets start to accept it as the “new normal”, and start focusing on other issues.
—
Policy differences between the two parties. To over-simplify: a Conservative government would be fiscally tighter, particularly in
the early years of the parliament; a Labour government would be more likely to impose extra regulation on certain areas of the
economy. The SNP, it if exerts any influence on policy, would want to be fiscally-expansionary.
—
Longer-term concerns over a “Brexit” referendum. The Conservatives have promised to hold a “Brexit” referendum by end-2017.
This commitment looks very likely to be honoured, but might just be abandoned as part of coalition negotiations. A Labour or
Labour-led government would not hold a “Brexit” referendum. The prospect of this referendum – even in the absence of
evidence that the British electorate would vote for a “Brexit” – might be negative for markets.
— Fixed income: Uncertainty could cheapen U.K. Gilts vs. U.S. Treasuries – but they might still have some appeal, particularly given the
outlook for German Bunds. One question is to what extent looser fiscal policy under a Labour or Labour-led government might
encourage the Bank of England (BoE) to raise rates earlier. (But the reverse is also possible: if a Labour government led to a decline in
confidence and thus slower growth, then a BoE rate-rise decision would likely be pushed back.)
— Equities: The U.K. market has underperformed the rest of Europe year-to-date, due in part to the positive impact of European Central
Bank (ECB) quantitative easing (QE) on Eurozone markets. In our view macro fundamentals of U.K. equities are largely defined by the
global economy and less so by the domestic economy or politics. Therefore, the election impact is likely to be temporary for many large
caps and limited to a few sectors like utilities (fear of increased regulation) or defense (lower spending) in case of a Labour-led
government. Only a prolonged period with no government formation at all could cause ongoing underperformance of U.K. equities. Any
Eurozone turmoil could move money back into the market. In recent years of financial crisis U.K. equities have outperformed the
Eurozone.
— FX: In general, the pound sterling is likely to continue to struggle against this background. Only a clear majority for one of the "big"
parties, preventing longer lasting coalition negotiations or even new elections, would strengthen Sterling in the weeks ahead.
Investments are subject to various risks, including market fluctuations, regulatory change, counterparty risk, possible
delays in repayment and loss of income and principal invested. The value of investments can fall as well as rise and
you may not recover the amount originally invested at any point in time.
Deutsche AWM expectations 2015. Forecasts are based on assumptions, estimates, opinions and hypothetical models or
analysis which may prove to be incorrect. No assurance can be given that any forecast or target will be achieved;
Deutsche AWM Investment GmbH, CIO Office; Deutsche Bank AG CIO Flash – Preview U.K. general election – Into the unknown – May 5, 2015.
Glossary
Explanation of terms
Bank of England - The Bank of England (BoE) is the central bank of England.
Brexit - Brexit is a combination of the words "Britain" and "Exit" and describes the possible exit of the United
Kingdom of the European Union.
Conservative Party - The Conservative party is a centre-right political party in the United Kingdom.
Democratic Unionist Party (DUP) - The Democratic Unionist Party (DUP) is a unionist party in Northern Ireland.
European Central Bank (ECB) - The European Central Bank (ECB) is the central bank for the euro. It
administers the monetary policy of the Eurozone, which consists of 19 European Union member states.
Eurozone - The Eurozone is formed of 19 European Union member states that have adopted the euro as their
common currency and sole legal tender.
Gilts - Gilts are bonds that are issued by the British Government.
House of Commons - The House of Commons is the lower house of the parliament of Britain. It includes
representatives from England, Northern Ireland, Scotland, and Wales.
Labour Party - The Labour Party is a centre-left political party in the United Kingdom.
Liberal Democrats - The Liberal Democrats are a centrist, social liberal political party in the United Kingdom.
Minority Government - A minority government is a cabinet formed in a parliamentary system when a political
party or coalition of parties does not have a majority of overall seats in the parliament.
Quantitative easing (QE) - Quantitative easing (QE) refers to broad-based asset-purchase programs conducted
by central banks; these assets can be government bonds, but also other assets like asset-backed securities.
Scottish National Party (SNP) - The Scottish National Party (SNP) is a nationalist and social-democratic
political party in Scotland.
Sterling - The sterling, also known as the pound sterling, is the official currency of the United Kingdom.
Treasuries - Treasuries are fixed-interest U.S. government debt securities with different maturities. Treasury
bills, also T-bills, mature in one year or less. Treasury notes, also T-notes, mature in two to ten years. Treasury
Bonds, also T-Bonds, mature in twenty to thirty years.
UK Independence Party (UKIP) - The UK Independence Party, commonly known as UKIP, is a eurosceptic and
right-wing populist political party in the United Kingdom.
CIO Flash – Preview U.K. general election – Into the unknown – May 5, 2015.
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CIO Flash – Preview U.K. general election – Into the unknown – May 5, 2015.
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CIO Flash – Preview U.K. general election – Into the unknown – May 5, 2015.