A Hung Parliament?

The British Pound may see an early boost from a final Greek bailout agreement but the currency looks particularly vulnerable ahead of the UK general elections as traders worry about the future of fiscal policy along with uncertainty at the polls.

The third televised contest between the candidates to take up the post of UK prime minister after the general election has come and gone, and while this final round was broadly given to the Conservatives’ David Cameron, the clear winner of the UK’s first experiment with such debate was clearly the Liberal Democrats’ Nick Clegg. The charismatic leader managed to pull his party out of the shadow of its larger competitors and make the election a proper three-horse race, meaning the seemingly predictable downfall of current Labour PM Gordon Brown will not translate into a Tory victory by default. Indeed, the Lib Dems are all but tied with the Conservatives in the latest opinion polls, hinting the election may produce the first hung parliament since 1974 as neither party is able to secure a clear majority.

A hung parliament (also known as a minority parliament or balanced parliament) is a legislature in which no political party has an absolute majority of seats. This situation is normal in many legislatures with proportional representation such as the parliaments of Germany and the Ireland, or in legislatures with strong regional parties; in such legislatures the term 'hung parliament' is rarely used since this is the typical outcome of an election.

This is a worrying prospect for the British Pound. Markets prefer a Conservative victory, hoping Mr. Cameron and co will make good on their promise to aggressively tackle the UK’s soaring budget deficit. The Lib Dems have not inspired such confidence, offering precious little in the way of details on how they would proceed on the matter. In any case, they too can’t hope for an outright majority and the prospect of a divided government incapable of charting a clear course for fiscal policy may prove bad enough to send Sterling lower in the election’s aftermath.

Elsewhere, the economic calendar seems relatively uneventful but risk sentiment may prove to be a factor early in the week, giving the Pound a boost if EU policymakers announce a finalized and expanded Greek bailout as expected over the weekend.

I respectfully disagree with the view in the Financial Times that gilts (debt securities) are higher on expectations of a Conservative win. I reckon their rise has just been an obvious reaction to falling equity markets. Generally, gilts are priced off German bunds, which have been flying as the safe alternative to most other European bonds. Ten year gilts are currently yielding just above 3.8%; they were over 4% a couple of weeks ago. One is almost inclined to short gilts now, but that would be madness ahead of the election result. A clear Conservative win would allow them to get to work on the deficit and the consequences could be so awful for the economy that even 3.8% for 10-years could look like a bargain. This in turn will keep the pound from dropping.