In the face of a national economic crisis, a Conservative government with a small parliamentary majority but a big opinion poll lead called a snap election. The Prime Minister campaigned on a platform of strong government with the authority to make hard decisions, while the Labour party were portrayed as hard-left extremists. But the gamble backfired, with the Conservative majority vanishing and Labour resurgent.
The date, of course, was February 1974.
Following a brief attempt at an informal ‘confidence and supply’ arrangement with Northern Irish Unionists, Conservative leader Edward Heath stood down, to be replaced by Harold Wilson. The Labour party leader was also short of an overall parliamentary majority. Wilson led a minority government for all of eight months but achieved little and called another election in October 1974, where he won a small majority. A series of by-election defeats meant that this majority was quickly eroded, forcing Wilson’s successor James Callaghan to seek support variously from the Liberals, Northern Irish Unionists, and Scottish Nationalists on a vote-by-vote basis during the late 1970s.
Fast forward to the present day, and the UK is living through a similar period of political upheaval. Just days before the start of Brexit negotiations, Conservative Prime Minister Theresa May called a snap general election. Her aim - to capitalise on her 20 percentage point opinion poll lead to improve her eight-seat parliamentary majority - failed. The election resulted in a hung parliament with no single party in overall control. This came as something of a shock. Betting markets at one point implied just a 4% chance of such an outcome - longer odds than were ever attached to the UK voting for Brexit or the US electing Donald Trump.
Markets are sanguine
Nevertheless, financial markets have taken the election in their stride. Relative to election day, sterling is nearly 2% weaker against the dollar, but gilt yields are little changed and the domestic-dominated FTSE 250 is almost a percentage point stronger. Investors appear to have concluded that the election result has few implications for the economy, and may have even increased the chances of an eventual ‘soft’ Brexit.
The UK economy has certainly proved resilient to other bouts of political uncertainty, including after the hung parliament in 2010 and the Brexit vote last year. In a speech last year, the Bank of England’s Kristin Forbes suggested that uncertainty has less effect on the economy when credit conditions don’t tighten significantly. It is encouraging, therefore, that gilt-overnight indexed swap spreads (which show the additional cost of unsecured borrowing) are unchanged since the election, while corporate bond spreads have risen only slightly. Meanwhile, evidence suggests there is only a weak relationship between a government’s parliamentary majority and subsequent economic growth. Under the Wilson and Callaghan governments between 1974 and 1979, for example, the UK grew at an acceptable – by modern standards – average annualised rate of 2.3%.
As it happens, we do expect the UK economy to slow over the next few years. Signs of weakness are already emerging in the retail sales figures. But this slowdown is primarily the consequence of a sharp spike in inflation following sterling’s large depreciation after the Brexit vote. Higher inflation is set to eat into real incomes, weighing on consumption growth and undermining the UK economy’s post-Brexit resilience.
There is some merit to the argument that the election result has increased the chances of a ‘soft’ Brexit.
Hard or soft?
Meanwhile, there is some merit to the argument that the election result has increased the chances of a ‘soft’ Brexit (defined as continued membership of at least the EU Customs Union, and probably the Single Market). The election result is being interpreted by many as a vote against Theresa May’s vision of a ‘hard’ Brexit, so the government may have an incentive to soften its stance to seek wider appeal. Indeed, Theresa May already appears to be coming under pressure from pro-Europeans within the Conservative party (including Chancellor Philip Hammond and Scottish Conservative leader Ruth Davidson) to soften Brexit. She could face similar pressures from the Northern Irish Democratic Unionist Party (DUP), with which she is entering a ‘confidence and supply’ arrangement to boost her numbers in parliament. Although the DUP is a pro-Brexit party, it does not want the return of a ‘hard’ border between Northern Ireland and the Republic of Ireland – a goal that may be best achieved by remaining inside the Customs Union. Finally, ongoing political uncertainty is eating into precious negotiating time. Potentially, this could make an “off-the-shelf” option such as Norway-style European Economic Area membership an attractive short-term fix.
But we would be cautious about putting too much weight on the argument that the election outcome has increased the chances of the UK remaining inside the Customs Union or Single Market. Recall that, when the election was called, a widespread market narrative had it that a substantial increase in the Conservative parliamentary majority would have softened Brexit. Now, a widespread market narrative has it that the loss of the Conservative majority could also soften Brexit. Can the market really have it both ways?
Indeed, it is far from clear that the election result really was a rejection of hard Brexit. After all, while Labour party rhetoric was softer, official party policy is also to take the UK out of the Customs Union and Single Market. Taken together, political parties supporting hard Brexit received an overwhelming 84% of votes. And while Theresa May could face increased pressures from pro-European members of parliament (MPs) in the Conservative party, she could equally be beholden to the many hard-line Eurosceptic MPs in her party. The DUP stance on a hard Brexit is also far from clear – the party wants control over immigration, the ability to sign trade deals with other countries, and an end to the jurisdiction of the European Court of Justice, none of which look possible within the Customs Union or Single Market. And even if the UK government does soften its stance, there is no guarantee that the EU would allow a soft Brexit. Indeed, much-needed reform of the EU architecture could proceed more easily with the UK out of the picture. Finally, the time taken up by the election and the indecisive outcome may have increased the chances of no deal at all – whether hard or soft – leaving a ‘chaotic’ Brexit on the cards.
One thing, as least, seems clear: never has the old Chinese curse “may you live in interesting times” seemed more apposite.
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