UK election 2017: Why the hung parliament spells trouble for its economy

Theresa May

Theresa May’s snap election wager has backfired. The supposed “Brexit election” was intended to signal the public’s support for the prime minister’s approach to the UK’s departure from the European Union. Instead, it has left her incredibly weak, without even a majority in government and her future as leader uncertain. And the economic data reflects this.

Markets hate uncertainty. One measure that tracks this is the UK’s index of Economic Policy Uncertainty, which shows diminishing confidence around the country’s economic resilience. It is calculated by tracking daily articles relating to economic and political unrest in more than 650 newspapers in the UK. The higher the number, the more turbulent the economic outlook. The index surged from 286 on May 18, 2017 to a staggering peak of 521 on June 8 2017, the day of the general election.

This is significant because higher levels of uncertainty are associated with greater stock price volatility and reduced investment and employment in key areas of the economy like healthcare and infrastructure.

The UK’s rising uncertainty levels stretch back to its EU referendum on June 23, 2016. Since then, GDP growth increased by only 0.84% while inflation rose by 1.09%. Uncertainty around the UK’s future relationship with the EU and the Brexit negotiations has caused sharp movements in currency markets as a result of investors hedging their bets and speculating on trades. The day after the referendum, the euro to sterling exchange rate fell by a massive 6.2% overnight, while economic policy uncertainty hit a record value of 2,661. It fell a further 5.1% from June 2016 to May 2017 and 3.42% during the month of May 2017, alone.

The next graph shows the daily linkages between the euro to sterling exchange rate changes and economic policy uncertainty since May triggered Article 50 on March 29, 2017. A negative value implies that as the uncertainty index increases, the sterling to euro exchange rate tends to fall.

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