With only a few days left before the UK general election on May 7, the financial markets in the United Kingdom have appeared surprisingly unconcerned by the possibility of a change of government, and one that is potentially much less stable than the coalition that has run the country for the last five years, and possibly much less friendly towards financial markets.
Although there is still time for the opinion polls to change, the relative stability of them in recent weeks suggests that no single party will win an outright majority in parliament which would require them to win 326 of the 650 seats in the House of Commons. If that was not achievable in 2010, it looks even less achievable today, with the emergence of some new political forces into the electoral landscape over the last five years and the resurgence of some older ones.
In fact, each of the main possible election outcomes will present potential risks to the economic outlook for the UK, suggesting that the current calm may well be a temporary quiet before an eventual storm. Even if the Conservative Party were to be elected outright, which seems unlikely, this would effectively guarantee the prospect of a UK referendum on EU membership in 2017, something that would be likely to destabilise sterling over the coming two years as the country debates the pros and cons of staying in the single market. At the other end of the scale the return of a Labour government would probably represent the most significant departure from the post-Margaret Thatcher economic consensus that has effectively run Britain over the last 30 years, with significant implications for taxation and public spending in particular.
Neither would the middle ground of a new coalition necessarily represent something that is much safer than either of those two extremes. A central role in a coalition government for a party committed to breaking-up of the UK, the Scottish National Party (or SNP), would clearly be unprecedented and potentially very disruptive. And a more chaotic minority government incorporating combinations of the Liberal Democrats, UK Independence Party, Scottish and Welsh Nationalists and Northern Irish parties would be by its nature very unstable as well.
There is a significant chance that next government will require support from three or more parties, given the expected decline in support for the Liberal Democrats over the last few years. After the relative stability offered by the ‘formal coalition’ between the Conservatives and Liberal Democrats, there is the chance that the next coalition that could govern Britain would be much less formal and more difficult to manage. The stability of the opinion polls and the unexciting nature of the election campaign might have lulled markets into a false sense of security that the government that will emerge will be equally stable and unexciting.
The reality might be precisely the opposite, as any failure to form a working government could quickly give way to calls for a second election.
Even this option, however, could be fraught with obstacles as the 2011 fixed term parliament act makes it very difficult for a minority government to call a second snap election. In the end a weak government may have to stagger on. The potential consequences for the UK economy are significant. Growth in the UK has been improving in recent years and is currently among the strongest in the developed world, notwithstanding the disappointing 0.3 per cent quarter on quarter reading in the first three months of this year. However, with a current account deficit of 5.5 per cent of GDP, and a budget deficit of almost 5 per cent much still needs to be done to complete the recovery from the financial crisis six years ago.
A dip in business confidence could quickly affect investment, and with consumer borrowing on the rise, any policy errors could quickly hit demand and output.
Fiscal policy will likely be the area that could see the biggest change of direction should the Conservative’s lose their grip on power, with the influential Institute of Fiscal Studies warning that the path to a balanced budget will be significantly delayed under a Labour led government. While theoretically this might be good for economic growth, by implying less fiscal drag, the greater risk is that continued high public spending impacts negatively on productivity, lowering the long term potential growth rate.
Complications related to the dominance of the SNP in holding a Labour government to ransom would add another dimension of risk, especially if the price for its support is another referendum on independence.
Tim Fox is the head of research and chief economist at Emirates NBD.
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