The pound slumped and domestically focused U.K. stocks sold off on Friday after Britain's ruling Conservative Party lost its parliamentary majority in the general election, clouding the outlook for investors just days before Brexit negotiations were set to begin.
Investors were divided over what the surprise results would mean for Britain's exit from the European Union, causing many of them to hold off on taking big positions. Some said less Conservative influence could lead to a softer Brexit, which they believe good for the economy, but others argued the increased uncertainty will make the divorce even more tortuous and unpredictable.
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In the short term, however, the direction was clear. The pound was volatile, tumbling to $1.264 at one point Friday, its lowest level since Prime Minister Theresa May called the general election in April. The currency showed signs of stabilizing in afternoon trading at around $1.275, but remained 1.6% lower than where it traded before an exit poll released Thursday evening pointed to a so-called hung parliament.
"The market is focusing on the uncertainty," said John Stopford, head of multiasset income at Investec Asset Management. "There are concerns about chaos, the risk of a bad deal and an inability to negotiate now the clock is ticking [on Brexit]," he said.
Worries about the political outlook rocked shares of U.K.-focused lenders and regional housebuilders. Banking stocks came under pressure amid worries that the main opposition Labour Party would gain influence, or even form a government, having promised a shake-up of the sector.
A period of political uncertainty could also keep interest rates lower for longer, which pushed down the yield of U.K. government bonds slightly to around 1.01%, according to Tradeweb.
The U.K.'s FTSE 250 index -- where around half of revenue come from abroad -- fell for much of Friday before ending little changed, even as the export-heavy FTSE 100 rose 1% as global companies that generate revenue abroad benefited from the weaker currency.
Still, traders described the environment Friday as relatively calm compared with past political shocks.
"The market is absorbing this result much better compared to the Brexit result, but a lot will depend on how things develop," said Geoffrey Yu, head of the U.K. investment office at UBS Wealth Management.
Mr. Yu said that rather than placing trades he would spend his time on Friday sketching out various scenarios and how that could affect markets.
"We don't have enough information yet to actually make a judgment," he said.
Investors' key concern is how the result will impact Britain's divorce from the EU, formal negotiations for which were set to start in 10 days' time.
The debate was whether the Conservatives' disappointing result will reduce the pressure for a more complete break from Brussels, which could be good for the pound, or whether the lack of a clear mandate for a governing party would weaken the country's hand in negotiations and fuel uncertainty.
The Conservative Party was already talking to a traditional ally, the Democratic Unionist Party, to enlist their future help in voting through its policies. But those seats will offer only a slim majority, meaning that the influence of pro-EU parties, like the Scottish National Party, will be key.
If the Conservatives fail to form a government, Labour would get its chance. The left-wing party is expected to take a less hard-line stance in Brexit negotiations and immigration, all of which business and investors want. It too would need to look to the likes of the SNP for support.
"A softer Brexit looks more likely, and a softer Brexit is also sterling positive," said Ben Kumar, investment manager at Seven Investment Management. Any government will need more cross-partisan support to secure deals, he said.
While Brexit supporters argue that the U.K. would be able to carve out new deals with trading giants like the U.S. and China, most analysts say the sort of clean break from the EU that Conservatives have advocated would be negative for the British economy, throwing up tariffs and obstacles to trade with its biggest partner and hurting the country's large finance industry.
But investors say there are multiple moving parts, all of which are hard to predict. If the Tories oust Mrs. May as its leader, for instance, that could trigger another election and more volatility. It could also lead to a more euroskeptic leader taking over the 'Tories'.
"The hung parliament is opening up the possibility of potentially a softer Brexit as well as what I would describe as a bad Brexit," said Michael Metcalfe, global head of macro strategy at State Street Global Markets, meaning the U.K. could run out of time to clinch a trade agreement or end up with a bad deal.
"The only thing that's certain now is that we probably need a bit of a risk premium attached to U.K. assets to reflect that uncertainty," he said.
Investors have become accustomed to political uncertainty in Britain over the past year, which could help explain why moves in financial markets haven't been more dramatic so far.
While few expected a minority government, U.K. asset prices had already factored in "a period of extended political uncertainty given the complexity of delivering on the outcome of last year's EU referendum," said Paras Anand, chief investment officer for European Equities at Fidelity International.
"Simply put, that we are facing a period of political uncertainty is nothing new," he added.
--Alistair MacDonald contributed to this article.
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(END) Dow Jones Newswires
June 09, 2017 12:42 ET (16:42 GMT)