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July 12, 2016

What to expect from Theresa May

The best thing about the sudden coronation of Theresa May as the UK's new prime minister from tomorrow is that it removed a big chunk of uncertainty. We is still not clear about her Brexit strategy, but yesterday she doubled down on her commitment that "Brexit means Brexit". She cannot conceivably extricate herself from that commitment.

In our view, her priority will be to complete Brexit before the next elections, due in 2020. One of the big questions pundits are asking is whether she will "call elections". The assumption is that she can simply do this, as though the fixed-term parliaments act was just an easily circumvented charade. Technically, this may be possible. One device would a no-confidence vote in which the government itself abstains. However, experience of other jurisdictions with similar rules - like Germany - tells us that the highest courts tend to take a negative view on such actions.

She might find new elections tempting politically, given the extraordinary weakness of the Labour party which is currently tearing itself to pieces. The latest ICM poll shows the Conservatives increasing their lead over Labour to 38% against 30%. We are surprised at how strong Labour's support is given the reported unpopularity of Jeremy Corbyn among his own MPs. The only way for the party's Blairite establishment to oust Corbyn would be through a procedural trick to keep him off the ballot, but that would almost certainly lead to a legal challenge by Corbyn. In any case, it would worsen the split in the party. Meanwhile, the Tories are uniting around May. It remains our baseline case that May will honour her pledge - no second referendum, no new elections.

The coronation of May also decreases the already very small probability that Brexit may somehow not happen, which is still a subject of obsession among some bitter Remainers. We hear from Labour MPs that they will not frustate a Brexit vote in the House of Commons. If elections were held soon, we doubt very much that the Labour Party would campaign on a theme to undo the result, or for a second referendum, given the impact that this would have on the marginal constituencies in the North and in the Midlands. Whether there are elections, or not, Brexit will thus go ahead. Our estimate is that it will happen in 2019.

The market reaction to May's victory was positive. The pound and the stock indices both went up. While the mid-market cap index is still down from the day before the referendum, the gap is now within the normal trading ranges for stock market indices. And the impressive alliance of the economics profession - united in their doom and gloom about Britain - is also crumbling. We noted a comment by Daniel Gros in La Repubblica this morning, in which he estimated the impact of Brexit to be a mere two points of GDP, stretched over a period of ten-years. That would make Brexit a relatively minor economic shock. This accords with our own view as well. That said, we also expect a recession to happen, but it will not be so bad that the country will have a collective rethink.

We heard one interesting theory, attributed to a close ally of May, that a recession would actually help reduce immigration and allow May a higher degree of flexibility in the negotiations. We think, too, that she will go for the Norway option, at least as an initial stage. That may be followed by an FTA, but we don't think that this can be negotiated and ratified in a two-year time period. The smartest strategy would be to get out of the EU before the 2020 elections, and then replace the EEA with an FTT during the next decade. The alternative would be a hard Brexit, which we don't think May would, or should, opt for.

There is much commentary around on May, most of it speculative and uninformed. Today, we would like to highlight three of the better ones. Janan Ganesh writes in his FT column that all the hard evidence we have from May - her refusal to guarantee the residency rights of EU nationals in the UK, her attempts to curb the number of foreign students - is pointing in the direction that she really means what she says about immigration. The free marketeers who hope that she will prioritise the single market may be disappointed. Ian Birrell, writing in the Guardian, is more pessimistic about May's premiership. While she has faced down the challenge from her right-wing opponents, she will probably fail over Brexit. She may find "her tenure wrecked by Little Englanders playing selfish games over Europe", he writes.

And Hugo Rifkind notes in the Times that the Tory party was sufficiently in favour of Leave to vote for Brexit, but not so much as to vote for a Brexiteer as prime minister. David Cameron did manage to remove the extreme right-wing elements from the party, which is now much more cohesive - and socially liberal - than it was before.

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