Britain will head to the polls on May 7th for one of the most tightly contested elections in history. It is a dead heat between David Cameron's Conservatives and Ed Miliband's Labour Party with on party likely to win an outright majority.
This can be an unsettling time for traders, especially if you have exposure to UK markets. Unlike in the US – where the campaign trail tends to run for months, if not years – elections in the UK are concentrated into a matter of days. This tends to concentrate the event risk over a short period of time.
The UK’s first-past-the-post the system also means no single party can rule alone without 50.1% of the vote. With both Labour and the Conservatives failing shy of the 326 seats needed for a majority, a hung parliament could ensue with a multi-party coalition, minority government or a re-run of the election all potential outcomes.
A look at past elections shows that financial markets tend to experience far more volatility when the outcome of the election is uncertain. After the 2010 election when there was no clear winner and a coalition government was formed after 5 days of negotiations, sterling experienced a large bout of volatility. The FTSE 250 index, a good measure of business sentiment in the UK, also fell sharply during this period. Contrast this with the election in 2005 when Labour won a large majority and we can see volatility in sterling was much smoother – the FTSE 250 also rallied after the 2010 election.
In addition to the uncertainty surrounding the vote, there are a number of election outcomes that could affect certain sectors of the economy. For example, Labour’s pledge to freeze gas prices until 2017 could hurt utilities like Centrica and SSE should a Labour-led government come to power.
Nick Beecroft, Saxo Bank’s Senior Market Analyst, believes we could see even more volatility in FX markets this election, in part due to the twin uncertainties: a hung parliament with minority government combined with a departure from the EU under a Conservative-led coalition with UKIP. Whatever the outcome, the election will likely to come to the fore in early May.
With the Scottish referendum still fresh in the minds of investors, sterling volatility is creeping in. The cost of insuring against volatility sterling over the next month soared to the highest in more than three years. Market jitters may even be felt months after the election should a coalition government fail to establish confidence in financial markets.
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