April 19, 2017 / 11:51 AM / 8 months ago

UK election will test markets’ Brexit optimism

LONDON (Reuters Breakingviews) - Theresa May’s plan to call an early election has raised investors’ hopes that Britain can avoid a damaging European Union exit. However, the assumptions which underpin their optimism will be tested during a campaign that will shed more light on the prime minister’s priorities.

Britain's Prime Minister Theresa May leaves Number 10 Downing Street in London, Britain January 24, 2017. REUTERS/Stefan Wermuth

The Breakingviews Brexit Index (tmsnrt.rs/2nEUUgf), which incorporates currency, bond, stock, and credit default swap prices, jumped to 95.8 on April 18 - the day that May sprang her election surprise. This was the second-highest reading since the June 2016 EU referendum for the indicator, which rises when investors anticipate a more benign “soft Brexit” and falls when they expect a harsher outcome.

There are two main reasons to be more optimistic. The first is the election gives May some breathing space between the 2019 deadline for concluding EU exit negotiations and the next UK ballot. Previously May would have had to face voters by early 2020. That deadline has now been pushed to 2022. This opens up the possibility of extending the timetable to clinch a deal.

Meanwhile, the prime minister is likely to have a stronger hand at home: opinion polls suggest the election will hand May a bigger parliamentary majority. That would make it harder for anti-EU hardliners to dictate the government’s negotiating stance on issues such as immigration and payments into the EU budget, allowing May to push for more favourable terms with the EU.

Both assumptions may be flawed, however. Just because May is likely to be premier until 2022 doesn’t mean other EU countries will soften their stance or give Britain more time to negotiate its exit. And if the ruling Conservatives emerge with a bigger parliamentary majority, it would be equally possible for May to ignore the pro-EU factions within her own party.

Her appetite to compromise on such topics as trade and immigration will become clearer on the campaign trail, when pressure from voters and other political parties will force the prime minister to clarify her policies. That could narrow her negotiating options - and puncture investors’ hopes for a softer Brexit just as quickly as calling the election has raised them.

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