How Will the Markets React to the Election?
The same morning Prime Minister Gordon Brown called a General Election for 6 May, the FTSE 100 reached its best intraday levels in 21 months.
The markets generally respond well to certainty, so it’s no surprise to see a short-term hike for financials now that the election date is set in stone. Equally, uncertainty over the outcome (and the knock-on effect for markets) may well be amplified as we approach polling day.
As the political parties prepare to set their election campaigns in motion, how will the financial markets react to intense media speculation, controversial polling data and contrasting plans for the struggling economy?
Sterling and the FTSE
Generally speaking, sterling and the FTSE tend to swing in opposite directions. This is because many major businesses’ earnings are in foreign currencies, so a weak pound generally boosts the stock market. Equally, a strong pound can dent the FTSE by reducing non-sterling earnings for the market’s key international companies. Therefore, if the Tories hold favour and the pound reacts positively to the party’s pledge to reduce the budget deficit, the flipside might be weaker equities.
While a recovery for Labour in the opinion polls may prove positive for equities, by lowering the value of sterling against the dollar and euro the lack of a clear budget-deficit strategy could possibly do longer-term damage to the economy. The threat of a credit rating downgrade on the UK, for example, could hit both the UK currency and the FTSE. Union leaders have also warned of possible strikes if the Conservatives go ahead with cuts in the public sector, which could add another layer of fragility to the stock market recovery.
Hung parliament
The day before the election date was announced, an ICM/Guardian poll gave Labour 33% and the Tories 37% - the closest ICM result since 2008. If voting holds true to this on election day, the UK would be heading for a hung parliament, even in the likely scenario that the Tories perform better in marginal seats.
When it comes to the financial markets, many analysts view a hung parliament as the worst-case scenario. As mentioned earlier, the market looks fondly on certainty, and the potential chaos of uncertain result has caused murmurings of a run on the pound. Although a weaker pound may nominally help equities, the ongoing effects of political uncertainty are just as likely to push the stock market the other way.
Increased volatility
As well as ongoing media speculation and high-profile opinion polls, the UK is gearing up for its first ever televised leaders’ debates, including one specifically on the economy on 29 April. This is almost certain to bring with it increased levels of volatility as markets react to perceived shifts in the balance of power between the three main political parties.
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