Strong and Stable?

9 June 2017

On 18 April, when PM Theresa May announced that she would ask the UK’s electorate to give her an enhanced Brexit negotiation mandate by way of an early election, my (well documented) view was that she would improve her majority and this should in turn be positive for the UK’s Brexit negotiation prospects, which turn should contain the Brexit damage for the economy. The argument was that she would have gained more headroom to negotiate compromises with the remaining EU, because of a larger majority and because she would have 2 more years until she faced re-election.

So, has the disastrous miscalculation that this election turned out to be for May’s government changed our views? Well, yes and no. As I wrote in my quick piece this morning, the way the UK public delivered its message might actually lead to a softer Brexit route, with the “no deal is better than a bad deal” approach certainly no longer a winning formula. This should be better for the UK economy, if the market’s verdict of the past 12 months’ is anything to go by.

On the other hand the UK’s government has certainly come out of this gamble weaker, not stronger and that cannot be an improvement to where we have been.

However, it has to my mind also shown that different to previous popular belief, the UK’s society had not united behind a general ‘let’s get on with it’ position toward Brexit. Instead the UK appears even more divided than it was a year ago. Not just rural versus city, professional versus basic skilled but with the young finally not just politicising, but actually turning up to vote, also young versus old. I would argue that this together with a less bold PM, might lead to a slightly less hostile reception on the EU side of the negotiating table, who can no longer take comfort from the argument that the British public is seeking a hard Brexit.

As so often over the past 2 years, markets reacted surprisingly sanguine to the political earthquake. £-Sterling fell as one would expect when political uncertainty rises, but with around 1.5% no further than it had done just after May’s announcement of the election back in April. So, no change then?

For the UK economy and capital markets it seems the verdict is ‘no better or worse’ than back in March. Clearly, the hung parliament outcome is a missed opportunity for more political stability or even strong majorities to address some of the UK’s structural problems and Brexit challenges, but no disaster compared to where we were anyway.

Only time will tell whether the May government will be allowed to how the political landscape of the UK will develop and what type of Brexit the UK’s political class will eventually pursue. Given all the very insightful commentary that I read over the course of Friday, I will leave the political assessment and speculation to the journalists, even if I have once again come to realise that despite all their very thoughtful analysis they seem less good at forecasting political outcomes than my combined team at Tatton.

We will therefore continue to focus on the economy at home and abroad and its prospects to expand or contract, which is ultimately what drives investments. From that angle we will once again this week travel around the world to observe whether our central case remains in place of has changed.

For the UK we have to report that there is more evidence again that it is the prospect of Brexit which is leading to a slowdown in growth, while short term domestic politics play a subordinate role.

In the US, Donald Trump continues to fail to deliver, despite constantly telling the public that he will announce some great policy initiative in the next couple of weeks and then does not. However, it also appears that his administration is slowly finding traction with their own Republican party, as they begin to explore compromises to at least have something to show before the year is out.

In the Middle East the Sunni Arab world has suddenly decided to isolate one of the biggest alleged financial supporters of radical Islamism – Qatar. Interestingly, this time around the resulting increased tensions in the Gulf have not led to a spike in oil prices, but a decline. We reiterate our view that global oil supply and demand dynamics have changed and require a new perspective. Until the oil exporters find out how to suppress the downward price pressures, the oil consuming world will enjoy an extended stimulus of being able to spend more money on more productive things than fossil fuels.

In the Eurozone, economic momentum pick-up has once again been confirmed by economic data flow, but more importantly the new ‘bail-in’ regime to stabilise failing banks has passed its first live test. Ailing Banco Popular in Spain was taken over and bailed out by Santander after the European Central Bank declared Popular unsound. However, importantly Santander did not have to take on the bulk of the debt burden which was instead written off at the loss of subordinated and contingent convertible (Coco) debt holders. The lack of credit market reaction in Spain informs us that the new system works, even though we would suggest it only works when a single bank falters, as was the case in Spain. In Italy, which has more than one very weak bank, the news from Spain did lead to a notable deterioration of bank credit conditions, which tells us that the new system will not be adequate to bail-in a whole section of a national banking sector.

Last but not least, returning to London we have found that Londoners have taken the attacks on London Bridge and Borough as what they are; a very sad and tragic derailment of human behaviours of a few, while the many have shown great resolve to fight back and not allow terrorists to succeed. City professionals returned to work on Monday as they do after every half-term and even if this time it happened right where we often go after work for a drink, markets didn’t even seem to flinch. Remarkable civil spirit shown once again and together with increased effectiveness of counter-terrorism efforts probably the best way to eventually eradicate this menace.

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