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?
The first thing to note is that the markets tend to favour certainty over uncertainty, so we may see a short-term boost for financials now that the election date is fixed. On the other hand, any uncertainty over the outcome (and the knock-on effect for markets of this uncertainty) may be amplified as we approach polling day.
Sterling and the FTSE
Broadly speaking, these two key UK markets move in an inverted pattern; because a large number of major businesses’ earnings are in foreign currencies, a weak pound generally helps the stock market whereas stronger sterling can dent the FTSE by effectively reducing non-sterling earnings for the market’s key international companies. Therefore, if the balance shifts in favour of the Tories, and the pound reacts positively to the party’s promise to slash the budget deficit, the flipside might be a more bearish view of equities.
On the other hand, while a recovery for Labour in the opinion polls may have the knock-on effect of helping equities, by keeping the value of sterling down against the dollar and euro, a failure to outline clear plans to tackle the budget deficit certainly has the potential to do longer-term damage to the economy. For example, even the spectre of a credit rating downgrade on the UK could hit both the UK currency and the stock market. Then again, union leaders have suggested that industrial action may take place if Tory plans to make cuts in the public sector are implemented and obviously this too could damage the stock market recovery.
Hung parliament
An ICM/Guardian poll published the day before the election date was announced put Labour on 33% and the Conservatives on 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 be firmly 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. We have discussed the market’s preference for certainty, and the potential chaos envisioned if there is an uncertain result has, in some quarters, led to talk of a run on the pound. As has been mentioned, a weaker pound may nominally help equities but 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, the one thing that seems certain is that we will 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: 06/04/10