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UK general election, GBP, forecast, fundamental analysisChart A: SourceAshcroft polls

The Conservatives look likely to have the hardest task ahead of the election. They will require a commanding lead of 6% or more over Labour to have a working majority in the next parliament.

Indeed, if we use the three poll average mentioned above as a proxy for the final outcome, then Labour would have a commanding majority of some 29 seats greater than the Conservatives’ predicted 287. 

Labour’s victory would be won at the expense of the Liberal Democrats, whose average poll showing of just 7.33% would see them lose two thirds of their parliamentary seats. Smaller parties, such as UKIP, SNP and the Greens are also predicted to win seats from the three established parties. On the current evidence, May’s election is likely to be one of the most closely fought in recent memory. 

Uncertainty in the markets

This lack of clarity creates a quandary for the markets and investors alike. Markets are happiest when they have a high degree of certainty about economic conditions and the direction that political policy is likely to take.

Under these circumstances market participants are able to make reasonable assumptions about asset prices and model probable future outcomes. However, the lack of a clear leader in the election polls throws up a myriad of possible outcomes. Or in other words, uncertainty. This is something which markets generally detest.

We have some very recent evidence of this phenomenon in play. Political risk showed itself very clearly ahead of the Scottish independence referendum in September 2014.

Chart B plots the pound sterling against the US dollar (blue line) alongside the yield on ten year UK government bonds, or gilts as they are otherwise known (green line). The area shaded in red highlights the market’s reaction to the then growing possibility of a yes vote in Scotland. The UK currency weakened against the dollar, whilst gilt yields briefly reversed their long-term trend and spiked higher. This inferred that government borrowing costs would rise in the event of a yes vote.

 

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