In April, British Prime Minister May announced early elections were to be held on June 8th in the UK. PM May was seeking to capture and utilise the unexpected popularity of the Conservative party post the triggering of Article 50 in late March 2017 so as to increase the size of the Conservative party ruling majority within the House of Commons. The current Conservative majority government has amongst the slimmest of majorities, with an absolute majority of just 5 seats and a working majority of 17.
Whilst polls have been more volatile in recent days, it remains our base case (70% probability) that PM May will increase the Conservative party majority at the election to between 50 and 100 MPs. It’s important to note the non-linearity of the UK’s FPTP election system in which just a 10% polling lead in the national vote share can lead to a significant majority of MPs. Our base case scenario will give PM May greater commanding power within both the government and the Conservative party, so as to ensure that a deep and comprehensive free trade agreement can be reached with the EU during negotiations in 2017 H2 and 2018 H1. Such an outcome would see GBP appreciate versus EUR/USD, but it’s also likely Gilts underperform based on higher than expected issuance given a slowdown in fiscal consolidation and the need to finance a significant Brexit divorce bill (around £50bn is our estimate).
We recognise the tail risks of a smaller Conservative majority than at present (10%) and a hung parliament (20%). However, we also note that in each of these scenarios the UK will most likely still exit the EU (albeit potentially after a 2nd referendum in the case of a coalition government).