UK election, a hung Parliament and the British Pound

Next Thursday May 7th, the UK will go to the ballot box to renew its government, in what many are calling the most important election in a whole generation, as polls are showing a tight run between the two major parties, the Conservatives, lead by David Cameron, and the Labour Party, lead by Ed Miliband, with none likely to win the majority. And whilst neither is close to the 326 seats required for a majority in a 650 seats Parliament, latest news show that the Scottish nationalists could win all Scotland's seats and smashed the usually dominant Labour Party there. 

The latest general polls show that the Labour grabs 20% of the vote intention, whilst Conservatives are three points behind.

Markets are always concerned about elections and the risk of a change in the economic policies. This time however, fears are related to the continuity of the UK in the EU.

Brexit

British Prime Minister David Cameron' Conservatives intend to renegotiate the terms of Britain's EU membership and hold a referendum on whether the UK should remain in the EU. Indeed the UK may suffer if it decides to leave the EU, but there are good reasons to believe Europe will also be hit. Europe is Britain's single biggest trading partner, but the UK has a large history of being a gateway into Europe, for the rest of the world, more reliable and trustful for foreign business.

So if the Tories win the elections on their own, something quite unlikely according to polls, Britain's membership in the Union will be at risk. And that will represent a even greater risk to financial markets, as when Scotland has its referendum to leave the UK, billions of pounds were wiped off the stock market. The immediate consequence of a Conservative win, will be therefore a strong slump in local share markets that will weigh also in the value of Pound. With latest polls showing that there are little chances the Party will get the 326 sits required, any winner will have to agree with some of the minors parties and form a coalition to govern.

Hung Parliament

Given that there's not a single political party that could win outright, investors are talking of the possibility of a hung Parliament that is, when no party has an absolute majority in the Parliament to govern on its own. That should end up with something similar to what the government is today, as the 2010 General Election produced a hung Parliament, and the Labour government remained in place until a majority was reach between Conservatives and Liberal Democrats. That opens the spectrum to several different scenarios, albeit seems hard to image a new government where none of the two major Parties would be involved.

If conservatives take the lead and manage to maintain the current Conservative-Liberal Democrat coalition, markets will likely be relief, and stocks can rally, but if the Labour wins, and allies with the Scottish Nationalist in a socialist pact, market's slump could be even bigger than with just a Conservative win and the potential risk of a Brexit, despite that the Labour Party has ruled out such possibility. Nevertheless, in this last case any effect over financial market will be short lived, whilst if Britain even attempts To leave the EU the effects will last much longer.

Effects on Pound

The GBP has been quite strong during this last months, advancing against both its major rivals the EUR and the USD on the back of a stronger economic recovery. Poor UK GDP readings for the first quarter of 2015 were erased by even worse developments in the US, whilst the ECB's decision to launch QE in Europe has kept the EUR subdued against all of its major rivals. And despite the risk and the talks, the Pound remains generally strong, having flirted with the 1.55 level against the greenback this week.

Taking a look at past elections in the kingdom, the Pound retreated before elections in most of the cases, but gained against the American dollar after the elections in four of the last five times the UK went to the polls. Later EUR strength seems for the most temporal, and limited against the British Pound, which suggest the GBP can also against its European rival this time.

Anyway, there's a good chance market will act the "sell the rumor, buy the fact" next week, with Pound probably under pressure until Thursday, and regaining the upside afterwards, should the outcome result less dark than expected.