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Economy | Equities | FX

UK Calls for Snap Elections

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UK Prime Minister May has called for a snap election on June 8th. This surprised the market which had expected elections in 2020, after the Brexit deadline. The sterling hit a 10-week high on hopes for a weaker opposition and prospects for a more orderly Brexit. The FTSE 100 fell 2.5%.

Focus now will be on how the composition of Parliament will change and what this means for the Brexit negotiations with the EU.

Why now?   

The UK government by now has accepted the notion that Brexit negotiations are likely to be lengthy, potentially resulting in a post-2019 transition period, given the elections taking place in France and Germany this year. This provides PM May with the opportunity to strengthen the size of her slim parliamentary majority (currently 330 out of 650 seats) as well as her personal mandate, having taken over the leadership from David Cameron when he resigned in July.     

Citi’s base case

Citi analysts continue to expect an eventual exit from the single market with a long transition period. They expect the majority of the Conservative Party to increase in the parliament by dozens of seats, mostly at the expense of the opposition Labour party. Overall, Parliament is likely to look less pro-EU than previously, supporting the Prime Minister’s plan for an orderly exit from the single market. This potentially lowers the economic risks relating to a chaotic exit.

Economic and Market implications:

GBP: Citi analysts had earlier indicated that investors may not want to be overly bearish on the sterling given its historically cheap valuations and investors’ already low exposures to the sterling.  With early election and the reduced risk a failure in negotiations, further downside to the sterling may be limited.

In the short term, Citi analysts see further sterling gains if GBPUSD closes above 1.2615-24, a key technical level, by the end of this week.  

Equities: UK economic fundamentals look healthy despite some modest downside risk from weaker consumption growth. Following the more balanced view on the sterling, Citi analysts prefer sectors that are less reliant on a weak sterling to outperform. Sectors that can continue to pay attractive dividends are likely to remain more resilient. The UK market’s dividend yield of 4.5% continues to look attractive compared to the yield on 10-year UK Gilts of 1.0%. Citi analysts’ mid-2018 forecast for the FTSE 100 stands at 8000 and they maintain a neutral allocation to UK equities within a diversified portfolio.

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