UK Election: More Political Volatility
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UK Election: More Political Volatility

Pound weakness underlines the Conservative Party failing to secure the expected Brexit mandate.

Exit polls from the UK general election point to the Conservatives winning just 316 seats, down from their pre-election 330 seats. The Labour Party could win 265 seats, up from 231 before the election. As such, the polls suggest the Conservative Party has failed to secure a significant overall majority and has fallen far short of initial expectations. This hands the Conservative Party a weaker mandate going into the Brexit negotiations than anticipated.

Pound as Shock Absorber

The initial reaction of markets to the election result has been negative, with the Pound falling approximately 2 percent. From an investor point of view, the potential tail risk of a Labour victory has been avoided, but there may now be questions over Prime Minister Theresa May's leadership and the agenda of the UK government in the Brexit negotiations. The Labour Party was the main winner of the night, whilst the Scottish National Party lost traction in Scotland. Risk appetite could be well tested in Friday trading.

There are several factors emerging. In general, the market risks will center on the UK. The pound will act as the shock absorber, though should it dip into the low 1.20s, it would begin to look attractive. Gilts will remain firm on this uncertainty (though would sell off under a Corbyn government). We do not necessarily see stocks rallying in response to a fall in sterling because there is now much greater policy risk in terms of the outlook for tax, Brexit and investment. Real estate may also be volatile.

Risk Appetite Could Be Tested

Broadly, the result may contribute to 'risk-off' at the margins in that it confirms the presence of angry societies and has shown that the British people are prepared to vote for the relatively very left wing suite of policies of Corbyn's Labour Party. The fact that he has done relatively well may make some speculate that the tide is turning on issues like corporate tax (higher), the power of large corporates and the need to address inequality, so the result is profits negative, in a sense. Fiscally, the election results signals a desire to end austerity.

Finally, from a UK macro point of view, the result means that the Bank of England will have a more dovish bias. There is a risk that the uncertainty it produces leads to a fall in business and consumer confidence.