Theresa May’s decision to call a snap general election is generally positive for UK gilts, sterling — which shot up to five-month high at the close of market on the day of the announcement — and Brexit negotiations.
The decision could prove a shrewd political move as it gives May a stronger hand when it comes to Brexit negotiations. If May wins, as expected, she will have more authority to drive a deal through parliament.
Currently, she realises she does not have a big enough majority to push through the changes. And with the latest polls showing the Conservatives are leading the Labour Party by 17 points, now is a good time to call an election.
With a strong majority, May will be able to pass legislation through more quickly and when she brings the final Brexit deal negotiated to parliament, it will most likely have the rubber stamp of approval. Europeans will also see this as a positive given that voting helps solidify that Brexit is real.
From a fiscal perspective, we haven’t seen the new manifesto, but it will likely remove some of the constraints that May and the Chancellor Philip Hammond have felt from the previous government. This will give them a freer hand to drive through policy as they see fit.
In general, what we have seen from Hammond and May is a fiscally conservative policy with less spending to reduce the budget deficit so that they have the capital required if Brexit does not go to plan.
From this perspective, the election is positive for gilts and for the pound as it removes one of the unknowns — whether May will be supported by the people or not. A victory could strengthen her position at home and on the international stage at a crucial time.
The election move is not without its risks. The subsequent negativity in the markets is more reflective of global trends overnight rather than a reaction to the news. Though there is an element of risk in both a shock election outcome — despite an opposition in disarray — and the risk that the distraction of an election weighs on economic growth, investment and consumer sentiment.
A more significant impact on equity markets would be a reversal of the currency impact, which has benefited a number of overseas companies listed on UK indices who have been enjoying the translation effect resulting from a weakening pound since Brexit.
There are already a few signs that the anticipation of a more stable Brexit negotiation could be a gamechanger for currency, potentially rallying the pound from its low levels and thereby removing the benefits that FMCG companies, in particular, have been relishing.
However, it is still early days and we will have to wait and see on this front. In contrast, the decision could boost UK domestic stocks who would see production costs overseas decrease.
We will no doubt see twists along the way, but the prime minister has clearly decided that the prize of long-term stability outweighs any potential short-term risk that may be caused by an election.
David Zahn is head of European fixed income at Franklin Templeton’s Fixed Income Group. Colin Morton is vice-president and lead manager at Franklin Templeton Funds.
