Hung Parliament creates more uncertainty but increases possibility for “Soft” Brexit
The UK General Election dominated the news flow last week, following the unexpected result. The Conservatives finished eight seats short of a majority and are now attempting to work with the DUP to form a workable government. The immediate reaction is that this will weaken the UK’s negotiating position with Brussels on Brexit and lead to a less stable domestic political situation, with potential for a leadership challenge. The ambiguity of this outcome has been bad for sterling initially. However, in the longer term there is a possibility that it could lead to the pound gaining strength as a “softer” Brexit outcomes may become more likely. A situation where the UK maintains an open trade relationship with the EU us seen as a strong positive for the pound. The fall in the sterling has helped the FTSE 100 stay at near record highs, however, smaller companies and the FTSE 250 have suffered slightly.
Unfortunately, there are several ways that this further political uncertainty can weigh on the real economy. Firstly, companies might put off investment decisions and households delay making major purchases, due to uncertainty about future government policy and economic situation. Furthermore, the stance on Brexit may well change, adding to this uncertainty. Even when a Government is formed, the fact that it will likely be a coalition, could make it harder to implement previously-pledged policies. Second, financial market volatility might also weigh on the economy. The increased risk perceived in the UK may force companies and consumers to pay more for borrowing or capital raising, limiting economic activity and investment. While gilt yields have fallen slightly, the spread that corporate bonds are trading at has widened, making it more expensive for companies to borrow.
Elsewhere, the spat between Saudi Arabia and Qatar continues to escalate. Saudi Arabia, as well as its allies, has cut diplomatic ties, closed their airspace to all Qatari air traffic and pressured other nations to follow their lead. The intention is to remove the current Qatari head of state from power, as he has been running an independent foreign policy counter to the Saudi lead. However, Iran and Turkey have sided with Qatar, opening up the possibility of conflict as these arch enemies size each other up. Given the level of oil production from those involved in the dispute, there is an increasing risk of a supply shock if it continues. Speculators may therefore be unwilling to short the commodity with these political tensions in the background.
|UK 10 Year Gilt Yield||1.04||0.99||-0.05||-4.81%|
UK inflation figures for May will be released on Tuesday. Later in the week both the Bank of England and the Federal Reserve will make interest rate announcements.