Financial markets have not priced in Britain’s shaky politics
Mar 28th 2015
THE British political system is noted for producing strong, stable governments. But that is changing fast. May’s general election may generate a chaotic result—something financial markets are being slow to recognise.
As in other European countries, voters are turning away from the mainstream parties. Britain’s first-past-the-post electoral system moderates the impact of this change. But the polls nonetheless suggest that both the Conservatives and Labour, the two parties that have dominated British politics for a century, will fall well short of a majority—as they did at the last election in 2010.
An average of four electoral models, along with the odds offered by Ladbrokes, a bookmaker, produces the following result: Conservatives 280 seats, Labour 273, Scottish Nationalist Party (SNP) 46, Liberal Democrats 25, UKIP 4 and others 22. With 650 seats in total, 326 are needed for an outright majority although, since five Sinn Fein (Irish nationalist) MPs tend not to turn up, 323 would be enough.
On those numbers, the current coalition of Conservatives and Liberal Democrats would not have enough seats to form a majority government, nor would a Labour/Lib Dem combination.
A formal Conservative/SNP deal would pass the numerical test but not a practical one: neither party would agree to it. Both Labour and the SNP have ruled out a formal coalition, which would in any case require the support of other parties (the Greens and the Welsh Nationalists, for example) to secure a working majority.
The most likely outcome, then, is that a minority government would take power, attempting to pass legislation on a bill-by-bill basis. The party with the most seats (on current betting, the Conservatives) would get the first chance to rule. But it would probably find it impossible to push through a financial plan that resembled its latest budget; indeed, Alex Salmond, the likely leader of the SNP at Westminster, has just said he would vote down any Conservative legislative programme.
Given that the SNP may well have the casting vote (it, too, benefits from first-past-the-post), Labour may end up in charge. But its programme would also be hostage to the SNP. Mr Salmond has made it clear he would be opposed to further austerity (as well as demanding an expensive high-speed railway line to Scotland). Either way, the creation of a minority government would lead to considerable doubt about the government’s fiscal position.
The last time a minority government took office was in 1974; a second election was called quickly. But the rules have changed since then. Now another election will take place only if a government loses a confidence vote (and no alternative can be formed) or if two-thirds of MPs vote for a new poll. That process (requiring many MPs to vote for early unemployment) would be another source of uncertainty.
Even if chaos is avoided, the results will not necessarily be market-friendly. If the Conservatives win, they are committed to a referendum by 2017 on exiting the European Union. That creates the potential for further uncertainty as the vote approaches. Some businesses may wait to invest in Britain until the result is clear.
A Labour victory would probably avoid a referendum, but investors would be worried about a perceived anti-business agenda of higher taxes and more regulation. The most market-friendly result might be a grand coalition of Conservative and Labour, but that is highly unlikely.
Ramsay Macdonald, the only previous Labour leader to agree to such a pact in peacetime, is reviled in party lore as a class traitor.
All this might not matter if the British economy did not have some significant weaknesses. Recent growth may have been strong (GDP rose by 2.6% in 2014) but the foundations look shaky.
Productivity is a big concern: output per hour is 2% below its pre-crisis peak. Andrew Haldane, the Bank of England’s chief economist, has suggested the next move in interest rates might be down, not up—hardly a sign of a buoyant economy. Britain’s current-account deficit, an annualised 6% of GDP in the third quarter, is equal to its highest level since 1955, making the country dependent on foreign capital.
As yet, markets show no sign of alarm. The FTSE 100 share index recently passed the 7,000 mark for the first time. Ten-year gilt yields, at 1.5%, are very low by historical standards. And though sterling is close to its lowest level against the dollar since 2010, it has held up well in trade-weighted terms, thanks to the euro’s weakness. All that may change abruptly in May.