SUDDENLY Britain looks a lot less attractive as a home for international investors. The Conservative party under Theresa May gambled on a snap election to deliver a “mandate for Brexit”. It unveiled a muddled manifesto that alienated voters and was out-campaigned by the veteran left-winger Jeremy Corbyn. The party lost its overall majority and will now be propped up by the very odd ducks in Ulster’s Democratic Unionist party.
The markets reacted less severely than might have been expected. That seems to be based on the view that a “soft Brexit” looks more likely. But it is far from clear that this is the case. David Davis, Britain’s Brexit minister, seems to be ploughing ahead with plans to leave the single market and the Labour leadership is unlikely to oppose this.
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Overall, we believe that the election outcome will hamper Brexit negotiations and increase fiscal risks, and therefore be negative for the UK’s credit profile. However, the Conservative Party’s reduced share of the vote may indicate a higher likelihood that a ‘softer’ form of Brexit might now be pursued, involving compromises with the EU that Ms May would not have countenanced previously, and which would be positive.
It will take time for the pattern to become clear. While Mrs May is incredibly weakened, the Conservative party does not want to face another election, which it might lose; changing prime ministers in the middle of the Brexit negotiations (while the clock is ticking) also looks destabilising.
The result is that investors face the choice between a weak and wobbly Tory government and a Labour administration which plans to raise taxes on corporate profits, executive pay, and financial transactions (the IFS described it as the biggest-ever peacetime tax hike), as well as nationalise key industries.
All this at a time when the UK economy is slowing under the impact of a squeeze on real wages caused by the fall in the pound (which weakened in the aftermath of the Bexit vote). A loss of business confidence is the last thing it needs. But a survey by the Institute of Directors found a remarkable negative swing of 34 percentage points in business confidence in the wake of the election result (pessimists outnumber optimists by 37 points) while the head of the Confederation of British Industry said there was a risk that business could cut back on investment. If the economy weakens further, that will undermine the government’s position. If the government fails to achieve the Brexit voters want (and it promised all the benefits of EU membership with none of the costs), that will also hit its popularity. There is also a hard core of Brexiters among backbench MPs who will resist any softening of Brexit terms.Perhaps the govermnet will limp on for two years. But there is a real chance Mr Corbyn will be in power by the end of 2019.
John-Paul Smith, a strategist at Ecstrat, put things very starkly.
The UK election is a seismic event along the lines of Mrs Thatcher’s victory in 1979, as it represents the polarisation of British politics into nationalist and redistributionist extremes which are likely to prove toxic for the UK economy and sterling over the coming decade. We can anticipate a steady shift away from the Liberal Governance Regime which has reinvigorated the UK economy over the past 38 years, towards a more State-Guided Regime, a scenario diametrically opposite to the one which was intended by the libertarian advocates of Brexit. Over the short term, the comparatively low valuation of sterling and UK equities may provide some stability, but on a longer-term perspective, direct and portfolio investors should factor a much weaker pound into their calculations, along with a fiscal regime which is much less favourable to the holders of capital. The UK with its propensity to run large current account deficits is almost uniquely reliant upon the kindness of strangers among the larger developed economies, so the repercussions of this shift are likely to be very severe indeed.
Others are bound to notice the shift. The cool Britiannia that welcomed foreign visitors and capital under Tony Blair may not exist any more.