After UK Election, a More Vexing Brexit

The Conservative Party’s surprise loss of its parliamentary majority in the June 8 British election may add confusion and delay to negotiations with the European Union over Britain’s departure from the EU. However, we still expect that Britain will be able to reach a trade agreement with the EU as part of its departure from the union.

Conservative Prime Minister Theresa May had called for the elections in hopes of increasing her party’s strength in Parliament prior to the start of negotiations over Brexit. Instead, they lost 12 seats and May now must seek to form a minority Conservative government, aided by an agreement with the Democratic Unionist Party of Northern Ireland. Because the seven Sinn Fein MPs from Northern Ireland do not take their seats in Parliament, May will have a working majority.

The top agenda item for the new government will be Brexit. The first summit with the EU since Britain began the formal process of leaving the union is scheduled for June 19, the same day as the opening of Parliament. Despite the Conservatives forming a minority government, our base case remains that they can reach a trade agreement with the EU. However, May’s relatively weaker power within the Conservative party means that the tail risks to an agreement—including the potential that the UK could leave the EU without a deal on future relations—have increased in probability.

Clearly assessing the election’s economic impact is difficult at this stage, but greater uncertainty about the progress of Brexit raises the potential for greater volatility in the pound–particularly to the downside. This poses upside risks to inflation forecasts, which are thus subject to upside pressures. As for growth, data confirms a weak start to the second quarter in the industrial and construction sectors; this is likely to be a theme for the second half of 2017 given the potential dent to confidence that this minority-government outcome has produced.

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