Against the tide: Election summer surprises
Two elections in Europe in a month will certainly ruffle the feathers of financial markets.
The surprise was the decision of Theresa May, the UK prime minister, to call a snap election for June after having said on several occasions that she would serve out her full term until 2020.
It seems that worries over internal party divisions on the terms of any Brexit negotiation with the EU changed her mind. And, no doubt, she could not resist the siren call of a 20% points lead in the polls over the opposition Labour Party.
She is likely to romp home in the election with a large majority, possibly the largest since Thatcher. Tactical voting might diminish the scale of the Tory majority, but not in a way that influences the outcome. The pro-Remain Liberal Democrats might regain some ground, but Labour looks set to be massacred.
That will put her in office until 2022, well past the two-year deadline for the Brexit deal and into a period of transition after. Then she can resist any pressure from extreme Eurosceptics – in or outside her party – for a hard Brexit.
By the time we get to the German federal elections in September, we should have a new pro-EU French president and a UK prime minister looking for a soft Brexit deal and willing to negotiate
There is the fly in the ointment, however, of the Scottish Nationalists, assuming they retain their dominance in Scotland. They will demand a new referendum on leaving the UK. And the Northern Ireland nationalists might also do so, if they gain a majority in their enclave. Both Scotland and Northern Ireland opposed Brexit in last year’s referendum.
May knows that a hard Brexit is terrible for the UK economy. The victory in June gives her the flexibility to go for a softer version of Brexit. A softer Brexit deal could include long periods of transition and more friendly trade and service agreements. A big electoral victory will also allow her to tell her loony hardliners – Brexit at any cost – to shut up or get out of the party. She will have an ample majority to cope with their exit.
In terms of UK assets, this is a positive – at least in the short-term while Brexit negotiations proceed on a more pragmatic basis.
However, all my misgivings about the long-term costs to the UK economy of any Brexit remain – for productivity, trade and financial services. Over-leveraged British households are being squeezed by declining real purchasing power, so the scenario of just 1% growth is likely. This will not be made up by either more capital spending or exports.
Nevertheless, sterling should enjoy a period of relative stability – at least against the US dollar.
But the euro will be more influenced by the outcome of the French elections, with Emmanuel Macron, a centrist candidate not associated with the public’s disillusionment about the two main parties, and Marine Le Pen of the National Front, making it through to the second round.
Even with Macron as president, all is not rosy for French assets, as Macron would likely face a Republican-led National Assembly in the June elections as he has no party of his own to speak of.
Co-habitation between a president and an opposition prime minister and assembly has happened before and usually it has worked to sustain economic stability, but it would probably mean that badly needed structural reforms in labour markets and the public sector would not take place yet again.
Nevertheless, by the time we get to the German federal elections in September, we should have a new pro-EU French president and a UK prime minister looking for a soft Brexit deal and willing to negotiate. That does not sound too bad for the euro.