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What could the upcoming UK election mean for Brexit?

On Dec.
12, the UK is holding a general election, and the outcome is difficult to
gauge. While the Conservative and Labour parties try to broaden the debate, the
dominant theme remains Brexit. To give us a preview of this important election,
I’m turning over today’s Weekly Market Compass blog to my colleague Paul
Jackson. Paul is based in our London office and has been tracking the election
news and polls closely.

Paul Jackson: Thank you, Kristina. Through
this election, UK Prime Minister Boris Johnson is trying to win a mandate that
will enable him to gain Parliamentary approval for his European Union (EU)
withdrawal agreement. If he is successful, the UK would in theory leave the EU
by Jan. 31, 2020, thus launching a process to negotiate the future trade
arrangement between the UK and EU. We believe that such an outcome is largely
priced into UK financial markets.      

A quick
glance at recent pollswould suggest
that Johnson has a good chance of realizing that plan. His Conservative Party has
been well ahead of Labour in the opinion polls (39% versus 28% based on the
average of the 10 most recent opinion polls).1 However, it should be
remembered that Theresa May started the 2017 election campaign with an even
bigger lead, only to see the gap closed.

There are
two main ways in which Johnson’s “orderly” Brexit could be derailed:

  1. If the sum of Conservative Party and Brexit Party Parliamentary
    seats is so large that it tilts Westminster into “hard-Brexit” territory (or
    the Brexit Party becomes the swing party), a no-deal outcome may win the day.
  2. If Labour wins or (more likely) there is a hung Parliament,
    the only solution may be to have a second referendum. 

We
suspect the first outcome would damage sterling while depressing gilt yields
and, probably, UK equities (especially those with a domestic UK orientation).
On the other hand, we believe the prospect of a second referendum (and the
prospect of no Brexit) would be good for sterling and UK equities (pending the
outcome of the vote).

Polls
indicate a gain for Conservatives

This is a difficult election to call with many moving parts.
Members of Parliament (MPs) have been standing down or switching parties,
various alliances have been formed between parties, and voters have been ignoring
traditional party allegiances in order to express their Brexit preference. But
while it’s impossible to predict the outcome with 100% certainty, we can gain
important clues from analyzing polls, party alliances, and history.

Figure 1 shows the results of our
constituency-by-constituency analysis, using regional swing factors in play since
the 2017 election. Based on recent opinion polls, this methodology suggests the
Conservative Party may gain 49 seats on top of its current 298 (reaching a
total of 347), and that Labour may lose 44 seats, falling to a total of 199. (The
Brexit Party would continue to have no seats in our analysis.) This would be enough
to give a Conservative majority of 44, which we estimate would be enough to get
Johnson’s EU withdrawal agreement through the UK Parliament and for the UK to
leave the EU on or before Jan. 31, 2020.

However, there are two alliances that could
change the outcome, given the UK’s voting system. The “Remain Alliance” between
Liberal Democrats, the Green Party, and Plaid Cymru covers 60 seats in England
and Wales, but our analysis suggests it could have a limited effect. However,
the decision by the Brexit Party to not stand in constituencies won by the
Conservatives in 2017 (which we are classifying as an “alliance”) could add
seats for the Conservative Party, largely at the expense of the Liberal Democrats.
We are assuming the Brexit Party continues to have no MPs after the
election. 

The upshot — illustrated in the last column of
Figure 1 — could be a 60-seat majority for the Conservatives, which we believe
would be enough to get Brexit done, or at least the first part of it.

Figure
1: UK Parliamentary seat projections

  2017
election
Current
seats
Projection:
Opinion polls
Projection:
Opinion polls
plus alliances
Conservative Party 317 298 347 355
Labour Party 262 243 199 199
Scottish National Party 35 35 49 49
Liberal Democrat 12 20 31 24
Democratic Unionist Party 10 10 8 8
Sinn Fein 7 7 5 5
Plaid Cymru 4 4 4 4
Green Party 1 1 1 1
Independent 1 24 1 0
Other 1 8 5 5
Total 650 650 650 650
Majority -16 -54 44 60

Sources: BMG, Savanta ComRes, Deltapoll, Hanbury, ICM, IPSOS MORI, Kantar, Number Cruncher Politics, One Poll, Opinium, Panelbase, Populus, Sky Data, Survation, YouGov, Wikipedia, and Invesco. Notes: Using the 2017 general election result as the starting point, the “opinion polls” projection is made by applying regional voting swing factors. The House Speaker is included in the “Other” category and not within their party’s count. “Opinion polls plus alliances” assumes the following: for the “Remain Alliance,” the votes for the Liberal Democrats, Greens, and Plaid Cymru are aggregated in favor of the party that has been nominated to fight the given constituency (the agreement covers 60 constituencies); for those constituencies won by the Conservative Party in 2017 (where the Brexit Party has said it will not present a candidate), the Brexit Party vote is now split between Conservatives and Labour in proportion to the votes received in 2017. There is no guarantee the projections mentioned will come to pass.

The
election is just the beginning

We believe the UK financial markets would
experience relief if Brexit gets done with an agreement.  However, even with an agreement, the real
work would start when negotiating the future UK-EU relationship. Hence, any market
relief may be short-lived as Johnson has said the transition period would not
extend beyond 2020, which we believe
is totally unrealistic. Rather, we believe the negotiation of a future trade
deal with the EU would likely take far longer, and something will have to give
— either the deadline could get extended or the UK could leave the EU with no
deal at the end of the transition period. Yes, a no-deal Brexit is still
possible.

Hence, what appears to be relatively good
news as 2019 draws to a close (an orderly Brexit) could turn to angst during
2020 as the real negotiations begin against the backdrop of an unrealistic
timetable. We believe the good news is now largely priced into UK financial
markets (sterling has recovered over recent months, for example) and suspect
that 2020 will see the return of volatility, especially if Scotland pushes for
an independence referendum and pressure grows in Northern Ireland for
reunification with Eire (both Scotland and Northern Ireland voted to stay in
the EU).

Caution is required, of course, as the mood
among UK voters can change during the election campaign (as it did in 2017) and
opinion polls may be a less-than-perfect guide (as we have seen in many
countries). However, it would take quite some change for the Conservatives not to
win a majority.

1 Source: Based on a 10-poll moving average
taken from the following firms: BMG, Savanta ComRes, Deltapoll, Hanbury, ICM,
IPSOS MORI, Kantar, Number Cruncher Politics, One Poll, Opinium, Panelbase,
Populus, Sky Data, Survation, YouGov, Wikipedia. Data as of Nov. 14, 2019.

Important
Information

Blog header image: Pbombaert/Getty Images

In a
“no-deal” Brexit, the UK would leave the EU with no formal agreement outlining
the terms of their relationship.

UK gilts are bonds issued by the British
government.

The opinions referenced above are those of
the authors as of Nov. 18, 2019.
These comments should not be construed as recommendations, but as an
illustration of broader themes. Forward-looking statements are not guarantees
of future results. They involve risks, uncertainties and assumptions; there can
be no assurance that actual results will not differ materially from
expectations.

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