Voting for uncertainty

    7 March 2015

    ‘So, what’s your election prediction?’ It’s a perfectly reasonable question, but one which has lately stumped me.

    There’s just no easy way to summarise what might happen on Thursday 7 May — at least not in a single-sentence spiel that works at a drinks party. And how do you answer those who, prior to polling day, are wondering where to park their money?

    In less than three months, the UK faces an election the outcome of which is extremely tough to judge. It’s almost certain we’re in for a ‘hung parliament’ with no overall majority, as the combined vote of the Conservatives, Labour and Liberal Democrats falls and voters flock to alternative parties that can no longer be dismissed as ‘minor’.

    The identity of the British government will then depend on frenzied negotiations between a variety of parties that could leave the world’s sixth largest economy in political limbo for weeks or even months. ‘The permutations of potential coalition partners mean post-election politics will be messy and stay messy for some time,’ says Rick Nye, managing director at Populus, a polling company. ‘With over a 90 per cent probability of a hung parliament, we’re facing the most uncertain period in British politics for 40 years.’

    A prolonged struggle over power-sharing — which could easily spark a second general election, as happened in 1974 — will in turn raise big constitutional uncertainties as parties press their agendas. Will Scotland vote again on independence? Could there be a snap referendum on the UK’s EU membership? Such doubts will at the very least unsettle investors, knocking equity markets as well as capital spending on plant and infrastructure.

    Various combinations of parties in government — in particular, a Labour-led administration propped up by the Scottish National Party — could also alarm foreign creditors, undermining UK sovereign debt. ‘As a “safe haven”, Britain has lately benefited from turmoil elsewhere,’ says Helen Thomas, founder of the Blonde Money financial blog. ‘If politics is suddenly more confusing, or the UK is possibly leaving the EU, that could definitely pose a risk for gilts.’

    These deep electoral uncertainties stem from the demise of two-party dominance. While Labour and the Conservatives typically gained more than 90 per cent of the vote during the postwar years, and almost 80 per cent as recently as 1987, that share has since fallen to well below two thirds. At the same time, having consistently commanded around 20 per cent of the vote, the Lib Dems are now polling less than half that level, turning smaller parties, once peripheral at Westminster, into potential king-makers.

    The trend away from mainstream parties has accelerated lately— not least because of Ukip. Having won 3 per cent of the vote in 2010, Nigel Farage’s party is on course to command a 12 per cent share in May, and has consistently outpolled the Lib Dems since early 2013. This reflects not just rising concerns over immigration and a ‘remote’ political elite, but a growing sense that the single currency is incoherent and the broader European project discredited. With Greek once again on a knife edge, any renewed euro-lurch, even if a dramatic ‘Grexit’ is avoided, will boost Ukip further and generate even more electoral uncertainty.

    Then of course there’s the even faster ascent of the SNP, which won just six Westminster seats in 2010 but could take up to 50 of the 59 Scottish constituencies in May, practically wiping out Labour north of the border. Last September’s referendum, in which independence was rejected by just a 5 per cent margin, clearly galvanised SNP support. With party leader Nicola Sturgeon naming ‘no more austerity’ as her price for propping up Labour, and her predecessor Alex Salmond probably returning to the Commons, the SNP could force Ed Miliband leftward, pressing a Labour government into higher debt-funded public spending and raising borrowing costs across the economy.

    While the Bank of England will probably react to an uncertain election by waiting for the dust to settle, further delaying any rise in base rates, other outcomes are possible. The UK is shouldering a record external deficit of around 6 per cent of national income. Part of this gap now derives from the investment side of the national ledger, as we’ve shifted from receiving interest on loans made to foreign governments to paying interest on much bigger net borrowings from abroad.


    Probability of a Labour/SNP coalition — the likeliest outcome, according to Populus


    Probability of a Labour/Lib Dem coalition


    Given that position, concerns about an incoming profligate administration could see a sharp drop in the pound. ‘If the UK were to suffer significant capital outflows, rates might even have to rise to protect the currency,’ says Helen Thomas. Even if the Bank of England does sit on its hands, actual borrowing costs facing firms and households are determined in the market. And the market will make up its own mind about the election and any messy aftermath, whatever happens to base rates.

    Populus calculates that both Labour and the Conservatives have only a 3 per cent chance of forming a majority government. Although the Tories look likely to win the most seats, Miliband has a two thirds probability of becoming prime minister, twice as high as David Cameron. ‘That’s because Labour has a wider choice of potential coalition partners,’ says Nye. ‘While the Tories are probably limited to the Lib Dems and Democratic Unionists, Labour can feasibly work with the Lib Dems or SNP, plus the Greens and Plaid Cymru.’

    The most likely outcome, with a 24 per cent probability according to Populus, is the Labour-SNP government feared by many investors. There’s only an 11 per cent chance, meanwhile, of another Tory-Lib Dem coalition, but a 20 per cent chance of the Lib Dems teaming up with Labour. Whatever happens, a close election campaign involving ever-sharper rhetoric and subsequent squabbling means we’ll see considerable financial volatility during the second quarter. If Labour does take office, banks and energy stocks will take a beating. Higher property taxes are also likely, commercial as well as residential. Should Miliband need to woo the Lib Dems or even the Greens, that could push up alternative energy stocks.

    The extra borrowing likely to follow a Labour government will put downward pressure on gilts and other related bonds. And whereas the reality of power usually tempers more radical impulses, the strains of formal or even informal coalition could result in policy extremism — not least if the SNP is holding Labour to ransom in a tight parliament. That could bring a series of sovereign downgrades, driving even the most sanguine UK investors towards gold and other ultra-defensive assets.

    Even if there is a Tory majority, or a Tory-led government, the relief felt by many might be shortlived as the issue of EU membership comes into focus. While Ukip is expected to win between five and ten constituencies, its candidates will influence many more — by taking decisive votes from the Tories in some seats and Labour in others.

    Thus as polling day approaches, Farage could become an explicit instigator of other parties’ policies — pushing Cameron (who has promised a referendum by 2017) and even Miliband (who still remains against) into an earlier EU vote. After the election, even a handful of Ukip MPs could play a pivotal role in the Commons, threatening to tip a no-confidence vote and sparking a second general election unless a snap referendum is held.

    National opinion polls don’t always translate into actual seats, of course. Yet polling is becoming ever more sophisticated, with the Populus numbers incorporating constituency-level surveys, as do the polls commissioned by former Tory party treasurer Lord Ashcroft. Both sets of data predict a Scottish Labour bloodbath and a hung parliament. And all this polling is likely to generate heightened tactical voting, increasing uncertainty even more.

    The UK equity market is heavily populated with global companies deriving much of their profits overseas, which should partially insulate index-trackers from domestic politics. Yet this election is happening at a time of swirling international uncertainty too: not just potential eurozone break-up, but East-West tensions in Ukraine and escalating turmoil in the Middle East, which could make for yo-yoing oil prices.

    It is this deeply volatile international backdrop which, along with domestic factors, makes me conclude that we’re facing the most uncertain period in peacetime British politics not just since the double election of 1974, but since the introduction of universal suffrage in 1928.

    So how’s this for a single-sentence summary of the upcoming election: ‘If you’re not confused, you don’t really understand what’s going on.’

    The era of stable governments is over

    lpJoin us on 23 March for a Spectator discussion on whether the era of stable government is over with Matthew Parris, James Forsyth, Jeremy Browne MP, Vernon Bogdanor and Matthew Goodwin. The event will be chaired by Andrew Neil. In association with Seven Investment Management. For tickets and further information click here.