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Post-Brexit PM Theresa May Inherits a Heavy Burden

The new British prime minister must unite the Conservative Party and secure a favorable divorce from the European Union.

  • By Tom Buerkle

In the end, the succession proved nearly as swift and unexpected as the event that triggered the U.K.’s political turmoil. After more than two weeks of vicious infighting unleashed by the Brexit referendum, Britain’s ruling Conservative Party anointed Theresa May, the Home Office minister, to succeed David Cameron after her last rival suddenly withdrew on July 11. Today she becomes the second female prime minister in British history.

May’s rise avoided a two-month leadership battle against Andrea Leadsom, a fellow minister and a darling of the Brexit camp, and markets welcomed the newfound signs of political stability. Yet the speedy succession merely papered over the Conservatives’ deep differences on European policy, leaving unaddressed for now the question of what relationship the nation wants with the European Union, its biggest trade partner.

“She’s definitely the best chance of the Conservatives being able to unite, but it’s going to be tough,” says Jacob Nell, chief U.K. economist at Morgan Stanley in London. “She’s got a small majority, and the party’s very divided over the EU.”

Nearly three weeks after the June 23 referendum, in which the British people voted by a 52-to-48 margin to withdraw from the European Union, the country’s political and business establishments are struggling to calculate the consequences. The result, which betting markets and most polls failed to predict, “shows how the political elite and the City are detached from what is happening in the real world,” says Martin Gilbert, CEO of $420 billion, Aberdeen, Scotland–based Aberdeen Asset Management.

The political disarray is unprecedented. Cameron announced his intention to resign within hours of the referendum result, saying he couldn’t oversee the U.K.’s exit after having led the Remain campaign.

Boris Johnson, the former London mayor who had headed the Brexit push and was widely expected to succeed Cameron, seemed to have no clue what to do with his victory, playing cricket on the weekend after the vote and then writing a newspaper column claiming that Britain would withdraw from the Union while retaining full access to the EU single market. His performance was so weak that his erstwhile ally Justice Minister Michael Gove drove him out of the succession race by saying Johnson couldn’t lead the party, only to have his own candidacy shot down by Conservative members of Parliament appalled by Gove’s disloyalty.

Leadsom is a staunch Brexit advocate, but she dropped out after getting hammered in the press for appearing to overstate her financial industry experience and for saying she would make a better prime minister than the childless May because she is a mother.

The Conservatives’ only saving grace was that the opposition Labour Party was in even greater disarray, after MPs staged a massive vote of no confidence in its left-wing leader, Jeremy Corbyn.

“I expected Brexit, but I wasn’t really thinking about political shenanigans,” says Gerard Lyons, a former economic adviser to Johnson and Standard Chartered Bank chief economist who provided much of the economic rationale for the Brexit camp.

That itself is a telling remark. Brexit may have deep and long-lasting economic ramifications, but it was above all a political decision. The idea that a vote to withdraw from the EU after 43 years — rending the very fabric of the U.K.’s political and economic relationships with the rest of the world — would have anything less than momentous consequences was one of the more glaring of the Brexiters’ miscalculations.

S&P Global Ratings and Fitch Ratings promptly stripped the U.K. of its AAA rating, with S&P citing a “less predictable, stable and effective policy framework.” Eight asset managers, led by Standard Life Investments, stopped investors from selling shares in billions of pounds’ worth of commercial real estate funds to prevent any worries about post-Brexit property values from causing a run on the funds.

Yet aside from a 10 percent drop in the value of the pound, or actually because of it, the financial fallout was limited. On July 11 the FTSE 100 index closed more than 5 percent above its prereferendum level; U.K. blue chips generate most of their earnings overseas and stand to benefit from a weak pound. The domestically oriented FTSE 250 index was still down 3.6 percent. Most analysts expect a weaker pound to cushion any economic downturn. Morgan Stanley predicts a “shallow Brexit recession,” while Moody’s Investors Service cut its forecast for 2017 growth to 1.2 percent from 2.1 percent.

The one certainty is that U.K. economic policy will be stimulative. Governor Mark Carney promised that the Bank of England would seek to counter any negative shock from the vote, and began by cutting banks’ capital charges by half a percentage point to encourage lending. The central bank is expected to trim its policy rate by 25 basis points, to 0.25 percent, at its July 14 meeting. Yields on ten-year U.K. government bonds plunged by more than half a point, to 0.76 percent.

George Osborne, the chancellor of the Exchequer, scrapped his plan to balance the budget by 2020, and May was quick to endorse that fiscal easing. Osborne also met with top executives of six global investment banks and promised to work with them to maintain London’s status as an international financial center. And he went to New York to drum up investor interest — “selling Britain to the world,” as he put it.

Although some investment banks had warned of job cuts in the event of a Brexit vote, Lyons says the EU’s recently revised Markets in Financial Instruments Directive, or MiFID II, will act as a “safety valve” for the City of London because it offers market access to third countries with regulatory regimes that are equivalent to the EU’s: “You do not have to be in the single market to sell into the single market.”

The equivalence standard remains untested, though, and the French government has already launched a charm offensive to lure bankers to Paris. “There isn’t a technical fix here” that guarantees the City’s status, says Nell. “There’s got to be a political deal.”

That leaves the heavy lifting to May, 59, a vicar’s daughter from a small town in Oxfordshire. She was of more modest means than many of her Tory rivals and attended public elementary and high schools, but May went on to study geography at St. Hugh’s College, Oxford. There she was introduced to her husband, Philip May, now a London-based executive at Capital International, the overseas subsidiary of U.K. mutual fund manager Capital Group, by her college friend Benazir Bhutto, the future Pakistan prime minister. Elected to Parliament in 1997, she first drew attention on becoming Conservative chair in 2002, when she warned the group’s annual conference that they risked being perceived as “the nasty party.” As Home minister since 2010, she earned a reputation as a euroskeptic although she supported Remain, sotto voce, in the referendum. Notably, she sought to fulfill Cameron’s goal of reducing immigration — a key issue behind the Brexit vote — by more than two thirds, albeit with little success.

Immigration will play a central role in the U.K.’s exit negotiations with the EU. In her favor, German Chancellor Angela Merkel has made clear that EU leaders, not the European Commission in Brussels, will do the negotiating. That will maximize the clout of Merkel, who favors a velvet divorce. But France and Belgium have vowed to block any deal offering the U.K. single market access unless it includes the free movement of people.

Squaring that circle will challenge May. Her opening gambit is to play for time, saying the U.K. should wait to invoke Article 50 of the EU treaty and begin withdrawal talks until 2017 so it can formulate its position. Even then, talks aren’t expected to start in earnest before late 2017, given that France and Germany hold national elections next year in May and September, respectively.

But if anyone thought May might backtrack on the referendum, she insisted that this lady was not for turning. “Brexit means Brexit,” she said in a speech in Birmingham setting out her agenda. “And we’re going to make a success of it.”

It was a remarkably ambitious speech that vowed to address not just Britain’s relationship with Europe but the economic inequality and insecurity that she believes contributed to the Brexit vote. May even promised to crack down on tax avoidance, executive pay and “corporate irresponsibility,” sounding at times almost like Corbyn or Bernie Sanders. “We don’t just believe in individualism but in society,” she said. “We don’t hate the state; we value the role that only the state can play.”

Try to imagine those lines coming out of the mouth of Margaret Thatcher if you want a clear sense of how much the financial crisis and the EU referendum have changed U.K. politics. Where this goes and how long it will take is anybody’s guess.

Visit Tom Buerkle’s blog and follow him on Twitter at @tombuerkle.

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