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UK election and market reaction: what you need to know

Financial markets are starting to contemplate what the UK election result — in which no party has a parliamentary majority — means for investors. Here is a snapshot of how key UK markets are reacting to a result few expected.

Sterling

As has been the case since the Brexit vote almost a year ago, the UK currency is taking most of the strain. The pound has touched its lowest level since April 18, the day Prime Minister Theresa May called a snap election designed to strengthen her hand in Brexit negotiations.

Stephen Gallo, a currency strategist at Bank of Montreal, said he expected the pound to stay in a range of “$1.2300 to $1.2950” in the coming sessions. While fresh political uncertainty is destabilising for the currency, analysts say Mrs May’s failure to secure a parliamentary majority may ultimately lead to a less economically damaging Brexit.

Derek Halpenny, a foreign exchange strategist at Japan’s MUFG, said that “the probability of a softer Brexit and a pullback on fiscal austerity will certainly help limit the negative impact of this lurch into political uncertainty”.

Gilts

The UK government bond market has been outperforming in recent weeks, as data suggest the economy is slowing.

The immediate reaction of the market also shows a split between the shorter-dated bonds, where yields have dropped, and those on longer-dated debt which have climbed in early trading on Friday. The yield on the benchmark 10-year gilts rose 3 basis points to 1.06 per cent, while the yield on 2-year was down 1bp to 0.01 per cent. Yields rise when prices fall.

“The uncertainty about who is in charge and how we will approach Brexit negotiations combined with the chance of another election all point to a demand for gilts as a haven,” said Paul Brain, head of fixed income at Newton Investment Management.

However, further weakness in sterling could prove inflationary and hurt returns for longer-dated gilts.

“The rolling back of austerity and the possibility of some giveaways to support a weak coalition, also softer sterling leading to higher inflation, should push yields up in the near term,” Mr Brain added.

Dean Turner, economist at UBS, wealth management, cautioned that “rising uncertainty about the economic outlook, fiscal plans of the new government, and the Brexit negotiations, will likely see gilt market volatility rise.”

Fixed income markets headed into the vote with a bullish bias, Royal Bank of Canada analysts said, leaving gilts more vulnerable to a pullback anyway.

Tom Rivers, senior strategist at pension consultancy Cardano, said gilt yields were “likely to rise” if Labour made a bid to seize power because of Jeremy Corbyn’s perceived “credibility deficit”. Before the vote, JPMorgan analysts predicted that an inconclusive result could see the yield on 10-year UK government debt rise by 10 to 20 basis points.

Equities

The UK stock market is showing an even bigger split in its reaction.

The FTSE 100, the blue-chip index that is home to a series of multinational companies which benefit from a weaker pound, rose as much as 1.3 per cent to 7,545.12. Sterling weakness makes UK exporters more competitive. It also polishes earnings generated in foreign currency when they translate back into pounds.

By contrast, shares in those companies more dependent on the UK economy came under pressure. The mid-cap FTSE 250, which is more exposed to the domestic UK economy, headed lower — falling 0.6 per cent to 19,626.32. Consumer stocks exerted the biggest drag, with housebuilder Crest Nicholson the biggest single faller with a 5 per cent decline. Its peer Berkeley Group was down 4.1 per cent.

Anthony Codling, an equity analyst at Jefferies, argued the declines may present opportunities. He pointed out that following the EU referendum UK housebuilders bounced back more quickly than anticipated.

Mark Haefele, global chief investment officer at UBS Wealth Management, said he remained underweight on UK equities versus eurozone stocks. “Higher political uncertainty is likely to more than offset any benefit from a marginally weaker pound, and we expect the earnings of UK companies to slow relative to those of eurozone companies,” he said.

Eugene Philalithis, portfolio manager of Fidelity Multi Asset Income, said FTSE 250 companies faced “significant headwinds in the months ahead” from the fresh political uncertainty, along with rising inflation which is eating into consumer spending.