Although polls had narrowed in recent days, a Conservative win had still been factored in by markets. Over the past weeks, a Conservative landslide was looking less likely and was reflected in a fall in sterling, but a coalition/minority government was not the central scenario in forecasts. As the exit polls indicated an inconclusive result at 10pm, we saw a drop in sterling.
The uncertainty in the make-up of our new government, as well as speculation as to whether May will survive as leader is likely to see a negative response in markets as we now have an uncertain policy mix as well as Brexit negotiations. This morning, when UK markets opened sterling had fallen 2% from the close of the previous day. It is worth noting that sterling remains above levels pre the announcement of the general election. Gilt yields are largely unchanged and the recent pattern of the FTSE 100 (last 12 months) continues; sterling weakness is lifting the index as international earners receive a boost.
The probable impact on the Bank of England is for interest rates to remain close to zero until there is clarity on the formation of the new government. The path of growth in the UK is likely to remain subdued with the weaker currency continuing to add upside pressure to inflation. Essentially the decision path for the Monetary Policy Committee is unchanged from a high level perspective. We wait for detail on the priorities of the new government to evaluate the impact on Bank of England forecasts.
Emma McHugh, Bank Economist.