Tone, timing key in UK election drama

By Peter Apps, Political Risk Correspondent – Analysis

LONDON (BestGrowthStock) – Britain’s election looks to have produced the most inconclusive result possible – a narrow victory for the right leaning Conservatives and a Labour PM who shows no inclination just yet to step aside.

Financial markets were prepared for many outcomes but not the scenario of a second-placed Labour, that has no possibility of cobbling together a stable coalition, clinging to power.

The pound, gilts and stock market all sold off on Friday. Markets want clarity fast. They want swift action on Britain’s record budget deficit. That much was clear from a bounce when Britain’s third party, the Liberal Democrats, indicated it was open to the idea of a Conservative government.

What the markets fear most is policy paralysis.

“The markets will want to know first what the final results are, but also how things develop over the weekend,” said Nomura political analyst Alastair Newton.

“But if we have a situation where we don’t have a government by Monday morning it could be a different matter.”

For now, Prime Minister Gordon Brown remains in office with constitutionally the first opportunity to form a government and with senior figures in his left leaning Labour openly reaching out to the centrist Liberal Democrats with offers of electoral reform, long desired by Britain’s smaller political parties.

The Conservative line is that Labour has lost its mandate to govern. Liberal Democrat leader Nick Clegg took the same line on Friday morning.

“It seems this morning that it is the Conservative party that has more votes and more seats though not an absolute majority and that is why I think it is now for the Conservative party to prove that it is capable of seeking to govern in the national interest,” Clegg said.

The most stable coalition in numbers terms would involve the Conservatives and Liberal Democrats, although on paper the parties are not natural allies. The Liberal Democrats are pro-EU, unlike the eurosceptic Conservatives, and like Labour they want to delay deficit cutting measures into next year.

“I think (Conservative leader David) Cameron and (Liberal Democrat leader Nick) Clegg could work together, but I think Clegg would find that difficult to sell to his party,” said Nomura’s Newton.

A meeting of the Liberal Democrat party on Saturday could prove key in determining who they support. In the meantime, markets will be watching policymaker statements closely for signs agreement could be reached.

TAKING AGGRESSIVE TONE?

“If you see senior figures from the major parties taking a very aggressive tone and not conceding to each other I think people may think it will take a lot longer to form a government and you could see a much more negative reaction,” said Wolfang Piccoli. “I think the tone so far has not been encouraging. They don’t seem to realize they need to manage expectations.”

Analysts said they expected much noise over the weekend as the parties secretly negotiated, but said the key decision-makers would play their cards close to their chests.

The key issue for investors — and credit ratings agencies which have already warned Britain could risk losing its AAA status — is addressing Britain’s record deficit. That makes passage of any emergency budget particularly important, not to mention the initial market reaction to it.

Market analysts have been saying that a broad coalition might prove more capable of fiscal tightening than a minority government. But the election result leaves parliament so finely balanced that even putting that together looks relatively difficult.

“Fiscal tightening on the scale needed to get back to fiscal sustainability may well not be politically sustainable in a minority government,” said Citi in a research note.

But Jefferies chief economist David Owen said he believed the Conservatives would be able to push through a budget either as a minority government or in coalition with the Liberal Democrats.

“I don’t think this result is a disaster for Britain,” said Owen. “It’s just a matter of getting through the next few days until Gordon Brown accepts the inevitable and resigns. I think we will wipe possibly get another election in the next 2 to 3 years time horizon but that is not what markets are looking at right now, they are looking at the immediate future.”

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Tone, timing key in UK election drama