Although we are still awaiting results from a few seats, the UK general election appears to have produced a hung parliament, with no single party gaining an absolute majority of seats. The Conservative Party has fallen short of retaining its majority by a handful of seats, but is likely to be able to form a government supported either formally or informally by the Democratic Unionist Party (DUP), which supported leaving the European Union. It is not yet clear whether Theresa May will lead this government.
The lack of an outright Conservative majority increases uncertainty about the path of Brexit negotiations. Not only will it give more voice to disparate views within the Conservative Party, but the position of the DUP as well as the other major parties will have to be incorporated in the negotiation process in order to pass exit legislation. Although the result increases uncertainty about the Brexit process, this need for compromise could push the government towards a more conciliatory approach to negotiations.
Government policy outlook
In terms of government policy, the Conservative manifesto was noticeably light on detail, giving the party some flexibility during the parliament, though their fragile position will make legislating more difficult. The manifesto still emphasised tightening fiscal settings, albeit more slowly than previously promised. However, the need for broader support to pass legislation could create incentives to relax austerity even further. The Conservatives still prefer lower taxes, but have dropped a promise not to raise them. Expenditure commitments were vague, although the detail suggests only moderate shifts from previous plans. The manifesto outlines only small changes to UK product and labour markets, likely leaving them among the most lightly regulated in the OECD. However, there are areas where the Conservatives have promised to become more interventionist, such as industrial policy, energy policy and minimum wages.Market implications
Initially we expect risk markets to stumble - sterling has already pushed a little lower as nerves build around potentially bumpy Brexit negotiations. On the back of these concerns, credit spreads are likely to widen slightly and domestic equities and Real Estate Investment Trusts (REITs) to underperform. Gilts are likely to strengthen, with market perception focusing on a more difficult Brexit negotiation process for a weakened government. Longer term, the market is likely to be more sensitive to how the eventual government affects policy and decision-making through the parliament.
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