Anxiety about the future course of the United Kingdom’s negotiations with the European Union (EU) has surged following the surprising outcome of the parliamentary elections last Thursday, in which Prime Minister Theresa May’s Conservative Party lost its majority, resulting in a “hung Parliament.” May called the early election, fully expecting an increase in the Conservative majority, which would strengthen her hand in the Brexit negotiations. That proved to be a colossal miscalculation. She now heads a minority government with a very uncertain future.
Brexit negotiations with the EU are scheduled to begin on June 19. The UK may request and be granted a delay of the startup, but the end date for the exit – March 2019 – appears to be firm. Negotiations would have to conclude some months in advance of that date to permit national government ratification. The 27 EU members are eager to begin, noting the complexity of the work that lies ahead. They have already agreed among themselves on the positions the EU will take, published detailed negotiating guidelines, and sent some position papers to the UK, including a demand for a financial settlement said to approach 100 billion euros, gross. No substantial preparations appear to have been made on the UK side in the period leading up to the election.
In an interview with various publications reported by CNN.com, the chief EU negotiator, Michel Barnier, said, “I need a British delegation on the other side of the table, a head of British delegation that is stable, accountable, and that has a mandate.” The current situation on the UK side is far from meeting that understandable standard. The political situation for May’s government certainly cannot be characterized as stable, and the mandate for the future negotiators has become highly uncertain.
The election results have forced the Conservative Party to seek the support of the small Democratic Unionist Party (DUP) of Northern Ireland. A coalition between the two parties would require full agreement on a joint program, and ministers from both parties would have to be included in the government. This development is unlikely: The DUP stands far to the right of the Conservatives, particularly on social issues such as gay marriage and abortion, and is associated with the Protestant side of the sectarian divide in Northern Ireland. The DUP supported Brexit but insists on maintaining an open border with the Republic of Ireland, the UK’s only land border with an EU member.
Rather than a coalition, there will be a “confidence and supply” agreement between the two parties in which the DUP agrees to support the Conservatives in key votes necessary to maintain the May government in power. Obtaining this support will require the Conservatives to make some commitments to the DUP. Talks between the two parties were still ongoing at the time of writing.. The anticipated agreement is questioned by some Conservatives, including former Conservative Prime Minister John Major, who told the BBC, “A fundamental part of that peace process is that the UK government needs to be impartial between all the competing interests in Northern Ireland” (reported by CNN.com). Historically, minority governments in the UK have been short-lived. The prospects for this one’s surviving through the next several years of Brexit negotiations do not appear bright.
There is a good chance that Teresa May’s time as head of the Conservative Party is limited. The very poor election results are widely considered to be the result of an inept campaign, designed by May and a small group of advisors – the two most important of whom have since departed – and a Manifesto written by the same group, which, with its promises of further austerity, and reducing immigration, and exiting from the single market despite business pleas to the contrary, was highly unlikely to attract voters. May had already had to replace her Eurosceptic advisors and agree to a more collegial approach to governing.
A sharp battle is developing within the Conservative Party. On one side are the Eurosceptic hard-liners who are urging May to stick to her “hard Brexit” position that no deal is better than a “bad deal” in which the UK would agree to ease its positions on immigration and opposition to the European Court of Justice in order to remain in the single market. On the other side are some cabinet members and other members of Parliament, along with strong voices from the business community, urging May to adopt a softer Brexit strategy that would first include rejecting the no-deal option – also referred to as the “brutal exit” or “falling off the cliff.” That course would have the worst possible economic effects on both the UK and the EU. The “soft” strategy would also include seeking to stay in the customs union and if possible the single market, moderating the Party’s position on the free flow of labor and migration, and taking a less rigid position on some aspects of European Court of Justice jurisdiction in areas where common rules and security cooperation are desirable. Bear in mind also that the Conservative leader in Scotland, Ruth Davidson, has called upon Mrs. May to pursue an “open Brexit” that “puts our country’s economic growth first” (Financial Times editorial, June 12).
This battle between party leaders means the final outline of the UK’s positions that are needed to commence negotiations remains highly uncertain. Moreover, given the divisions within the Conservative Party and the weak position of the government, there is a risk that agreements reached in the negotiations will not be confirmed by Parliament.
Another election is possible given this unstable situation, even though the Conservatives would likely wish to avoid this outcome before strengthening the party’s support among voters. A change in leadership would likely have to come first. Labour gained 30 seats and 40% of the total vote in last week’s election. Nevertheless, they would have a formidable task overcoming the Conservative lead at this time. Yet a new election cannot be ruled out. This is another cause of the uncertainty facing markets.
One reminder of the importance of the Brexit negotiations for both the UK and EU was the release on Tuesday, June 13, by the EU of a draft law to give it the power to move the lucrative euro clearing business from London and house it instead within the EU after the UK exits the EU. London currently accounts for three quarters of this business, which provides thousands of jobs. There is a concern that an important part of the EU securities and derivatives markets would cease to be covered by the EU’s rules and regulations. This will be one of many important issues that will have to be addressed in the negotiations.
Markets do not like uncertainty, and uncertainty about developments in the UK and the likely course and final outcome of the Brexit negotiations has increased substantially. Yet the reaction in markets so far has been relatively subdued, clearly much less dramatic than the reaction to the shock of the vote approving Brexit almost a year ago. The largest UK ETF, the iShares MSCI United Kingdom ETF, EWU, at close of business June 13, was down only 1.3% since June 7, the day before the election. Similarly, the CurrencyShares British Pound Sterling Trust ETF, FXB, which tracks changes in the value of the currency relative to the US dollar, has declined a similar amount, 1.6%, according to Yahoo Finance.
These small reactions are understandable, as the UK’s decision to leave the EU was not expected by markets, whereas Brexit is now accepted as unavoidable; but the nature of that event has become more uncertain. Before the election, a hard Brexit was the clear intention of the government, whereas now a softer exit has become more possible, while at the other end of the spectrum, the possibility of no deal being reached and a brutal exit has also increased, in view of the weakened position of the government. In Cumberland’s International and Global Portfolios we expect to maintain our current underweight exposures to the UK while closely monitoring developments.
Sources: Financial Times, CNN, BBC, Yahoo Finance.
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