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Hung parliament risk to economy after British vote

Economists and investors are anxiously watching Britain's elections Thursday, amid fears an uncertain result could send stocks and sterling plunging -- even if risk has already been partially priced in.

world Updated: May 05, 2010 17:03 IST
Alice Ritchie
Alice Ritchie

Economists and investors are anxiously watching Britain's elections on Thursday, amid fears an uncertain result could send stocks and sterling plunging -- even if risk has already been partially priced in.

The pound slumped in March when it was first suggested that no party would win an outright majority -- a scenario that is looking increasingly likely as polls put the Conservatives ahead but still short of a parliamentary majority.

The currency has since stabilised but the risks remain, while stock markets have a history of responding badly to uncertainty and any delays in tackling Britain's budget deficit due to coalition talks could spook investors.

On the flip side, the markets have had weeks to adapt to the idea of a hung parliament, while analysts suggest the bail-out of debt-ridden Greece has caused a bigger financial shock than any political events in London could do.

Conservative business spokesman Ken Clarke has been leading the doomsday predictions, warning a hung parliament could see sterling "wobble" and delays in tackling the deficit could prompt action by the International Monetary Fund.

"Fooling about with multi-party debate in what we call a hung parliament will be the equivalent of fiddling while Rome
burns," he said.

Whoever wins the election, the priority will be to cut the deficit, which stands at 163.4 billion pounds (247 billion dollars, 189 billion euros), or 11.6 percent of gross domestic product -- the highest level since World War II.

Britain only emerged from a long recession at the end of last year, and the 0.2 percent growth in the first quarter of 2010 was lower than expected.

With an eye on the Greek crisis, Prime Minister Gordon Brown's Labour party, the Conservatives and the Liberal Democrats have all pledged tough action to cut the deficit, although only the Tories would begin this year.

Alastair Newton, senior political analyst at Nomura, said the agreement on what needed to be done was crucial, saying: "Fiscal policy is likely to be very tight whatever the election outcome."

The latest polls suggest the Tories will win the most seats in Thursday's vote, but Labour could stay in office if there is no clear winner while both jockey for support to form a government.

Differences over whether to cut spending or raise taxes could be crucial in the subsequent negotiations.

"Within a coalition, difficulties in reaching agreement and distractions could leave the market underwhelmed by the extent of fiscal consolidation," warned Lee Hardman of The Bank of Tokyo-Mitsubishi UFJ.

Such a scenario could "significantly" increase the risk of Britain losing its cherished AAA credit rating, he said -- which would be a massive blow.

Moody's has said a hung parliament would not directly affect Britain's ratings, but Standard & Poor's has kept Britain on a "negative outlook", meaning the rating could be lowered, pending a reassessment after May 6.

A hung parliament could also send the pound spiralling, and Barclays Capital economists Adarsh Sinha warned the uncertainty of such a situation meant "risks remain significantly to the downside for the pound over the short term."

However, You-Na Park at Commerzbank suggested the risks were "likely to have already been priced in by markets, so that downward risks are limited in our view" -- and said a new government could even cause the pound to rise.

As for the stock markets, the ripples caused by the Greek bail-out will likely overshadow any political concerns in London.

"The possibility of a hung parliament has not helped sentiment, but this has arguably already been priced in and overtaken by wider events such as the European debt situation," said Richard Hunter, analyst at Hargreaves Landsdown stockbrokers.