On the morning Prime Minister Gordon Brown announced a General Election for 6 May, the UK’s leading stock index, the FTSE 100, hit a fresh 21-month intraday peak.
As the major political parties gear up for a sprint finish, how will the financial markets react to heightened media speculation, fresh polling data and manifestos filled with newly-unveiled economic policies?
Markets in general tend to favour certainty over uncertainty, so with a fixed election date we may see a short-term boost for financials. On the other hand, any uncertainty over the outcome (and the knock-on effect for markets due to this) may be amplified as polling day approaches.
Sterling and the FTSE
Broadly speaking, the sterling and the FTSE move in an inverted pattern because a large number of major business earnings are in foreign currencies. Where a weak pound generally can help the stock market, a stronger sterling can dent the FTSE by effectively reducing non-sterling earnings for key international companies. Therefore, if the balance shifts in favour of the Tories, the pound may react positively to the party’s promise to slash the budget deficit. However, on the flipside it might bring about a more bearish view on equities.
On the other hand, a recovery in the opinion polls for Labour may have the knock-on effect of helping equities, by keeping the value of sterling down against the US dollar and euro. However, a failure to outline clear plans to tackle the budget deficit certainly has the potential to do longer-term damage to the UK economy. For example, even the spectre of a credit rating downgrade on the UK could hit both its currency and the stock market. Then again, union leaders have suggested that industrial action may take place if the Tories plans to make cuts in the public sector are implemented, which could also damage the UK’s stock market recovery.
Hung parliament
An ICM/Guardian poll published the day before the election date was announced put Labour at 33% and the Conservatives at 37% - the closest ICM result for almost two years. If these figures were to be translated into real votes on 6 May, the UK would firmly be in hung parliament territory, even if (as seems likely) the Tories outperform Labour in marginal seats.
As far as the financial markets are concerned, many analysts see a hung parliament as the worst-case scenario. The potential chaos envisioned if there is an uncertain result has, in some quarters, led to talks of a run on the pound. While a weaker pound may nominally help equities, the longer-term effects of political uncertainty are just as likely to send the stock market the other way.
Increased volatility
With live debates scheduled between the three major party leaders (including one devoted to the economy on 29 April) as well as ongoing media-driven speculation and high-profile opinion polls, we expect to see increased levels of volatility as markets react to perceived shifts in the balance of power between Labour and the Conservatives.
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Updated: 08/04/10
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