UK elections: Asymmetric risk to sterling

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The political landscape has not changed much since campaigning for the 7th May UK General elections started nearly a month ago. One-on-one interviews of Prime Minister David Cameron and opposition leader Ed Miliband, two televised debates featuring the main party leaders and the launch of the party manifestos have yielded much noise but ultimately shed little light on how and by whom the country will be governed in the next five years (See Figure 2).

On current form, Labour and in particularly the Conservatives will struggle to shape a two-party coalition with a working majority (323 seats), let alone govern single-handedly. This opens up the prospect of a minority government, an unprecedented three-party coalition or a two-party coalition having to seek support from at least one other party on key votes. The UK Election Predictor, which I devised in March, is arguably still as relevant today in analysing how seats numbers are likely to translate into actual government configurations.

Olivier desbarres uk assymetric polls

Figure 1: Sterling is back near seven-year highs…but risks are to the downside

My core scenario with the elections only seven days away is for Labour to win fewer seats than the Conservatives but to seek an informal, narrow-majority, coalition government with the SNP. This scenario, which bookmakers are currently pricing in, would likely see the recent sterling rally reverse (see Figure 1). The second most likely scenario is a repeat Conservative-Liberal Democrat coalition, with either a much smaller majority – marginally sterling positive – or one which has to rely on support from smaller parties (e.g. DUP) on key parliamentary votes – neutral for sterling. There is a third scenario which few consider feasible but deserves consideration: a Conservative-led government with SNP support, which near-term would likely put pressure on sterling.  In any case sterling volatility, which as I forecast in UK General Elections – A riddle, wrapped in a mystery, inside an enigma has risen in the past six weeks, is unlikely to subside in the run-up to the elections or in the following days.

Olivier desbarres next government

Figure 2: Likely make-up of next government remains a close call

Labour-SNP Coalition – How to unbreak a promise and not lose credibility

Labour and Conservatives are still broadly level in the polls on around 34%, according to the BBC Poll of Polls, leaving them way short of a parliamentary majority. Neither party has seemingly taken advantage of UKIP’s loss of support. Cameron and Miliband have exchanged numerous political punches but neither has succeeded in landing a killer blow.

Labour has seen its predicted number of seats fall to around 270 and while Miliband has marginally improved his public standing he still polls poorly both on economic competence and likeability. Conversely, the Scottish National Party (SNP) has put in a strong showing and is now predicted to win about 50 of the 59 parliamentary seats up for grabs in Scotland.

Figure 3 shows that while a Labour-Liberal Democrat coalition is unlikely to have a working majority even if it forms a loose alliance with one or two of the smaller parties, a Labour-SNP coalition may conceivably have a majority. The sticking point is that Miliband said publicly on 26 April “No coalition, no tie-ins, I have said no deals. I have been clear about that. I am not doing deals with the Scottish Nationalist Party”. Reneging on that promise would likely cost him political capital and credibility.

However, if the SNP voted with Labour on key votes because they fundamentally dislike the Conservatives and can extract concessions from Labour, Miliband could have the majority he seeks – via an implicit confidence-and-supply arrangement – without having to explicitly U-turn. We’re in the realms of political semantics but that’s what it may come down to. SNP leader Nicola Sturgeon has made clear that her party’s demands would likely include greater devolution and fiscal spending and revisiting the issue of Trident. Labour will be hoping that the threat of letting the Conservatives back into power curtails her wish-list but expect fraught negotiations between the two parties.

In practise, the SNP could make clear that it would vote down the Queen’s Speech and budget, in effect aligning itself with Labour (see Figure 4). So while Cameron may be the incumbent prime minister and likely leader of the party with the greatest number of seats, the Queen may have to ask Miliband to form the next government. A more messy approach would be for Labour and the SNP to call and win a no-confidence vote in a new Conservative-led government.

The impact on sterling of a Labour-SNP coalition, however tacit, is likely to be negative as markets will be concerned about the day-to-day mechanics of such a coalition, the risk of larger budget deficits and renewed talks of Scottish devolution.

Figure 3: Coalition government is most likely outcome but how many parties will it have olivier desbarres

Figure 3: Coalition government is most likely outcome but how many parties will it have

Conservatives-Liberal Democrats: still an outside chance of another five years

The Conservatives have seemingly failed to capitalise on the UK economy’s relatively strong performance and robust employment data, hindered in part by the real wages’ collapse in the past five years (see UK labour data not helping Conservatives, 17 April 2015). Preliminary GDP data for Q1 showing a marked growth slowdown to a two-year low of 0.3% quarter-on-quarter are unlikely to help.

Support for the Liberal Democrats, the ruling Conservatives’ coalition partner, has flat-lined around 8-9% for months but political analysts on average forecast it to win slightly more seats (24) than back in March (22). Importantly, Nick Clegg has stated a willingness to be part of a ruling coalition, with either the Conservatives or Labour (see Figure 5).

On present forecasts, a Conservative-Liberal Democrat coalition would have 305 seats, 18 short of a parliamentary working majority (see Figure 3). The Northern Irish parties are likely to again win all 18 seats up for grabs, Plaid Cymru is on course to win 3-4 seats and the SNP is predicted to win about 50 seats. That’s around 72 seats the Conservatives are unlikely to take. Add in the seats the Greens and UKIP are likely to win and the Conservatives can say goodbye to around 75 seats.

The bottom line is that if the Conservative-Liberal Democrat coalition is to have another five years in power, it needs to make serious inroads into Labour’s electorate and parliamentary seats. That has so far proved difficult, but is not impossible. Previous elections suggest that Conservatives, Labour and Liberal Democrats tend to outperform when polls indicate a loss on the previous election. If this pattern holds true the Conservatives and Liberal Democrats may actually perform better than suggested by the polls while Labour may under-perform.

Olivier desbarres political timeline

Figure 4: Coalition negotiations likely to dominate political timeline

A Conservative-Liberal Democrat coalition, even one with a wafer-thin working majority, would likely be positive for sterling. At the very least markets would broadly know what to expect for the next five years. However, I would not expect sustained or significant sterling appreciation, for two reasons. First, the Conservatives would likely have to dilute some of their market friendly policies in exchange for Liberal Democrat support and Cameron’s commitment to hold a referendum on the UK’s membership to the EU is a sword of Damocles. Second, the sterling effective exchange rate (EER) is already near multi-year highs (see Figure 1), whereas sterling was near multi-year lows in the run-up to the 6th May 2010 UK elections. To put it in context, the sterling EER is up 14% since May 2010 and importantly I do not expect the Bank of England to hike its policy rate in coming months.

A three-way coalition including the DUP, whether formal or informal, is more unlikely as the Liberal Democrats have made clear they would not want to share power with a third party. In any case such an outcome would be neutral to slightly negative for sterling near-term, in my view. How such a political arrangement functions in practise is likely to partly dictate how sterling performs medium-term.

The Conservatives may have an alternative strategy, albeit one currently seen as fanciful – a coalition of sorts with the SNP. Whereas Labour may genuinely want to keep Scotland within the UK in the hope of regaining the seats it will lose in Scotland, the Conservatives would in practise have less to lose from a devolved Scotland. It’s also noteworthy that in 2001-2005 and 2005-2010, a majority of SNP and Conservative MPs voted the same way on respectively 64% and 71% of House of Commons votes, according to the House of Commons Library. A Conservative-SNP arrangement may ultimately prove unstable and usher in changes of personnel (e.g. Boris Johnson as leader of the Conservatives) but don’t discount it quite yet. Near-term sterling would likely weaken and be very volatile as markets would fear referendums on both the UK’s EU membership and Scotland’s membership of the UK as well as more left-leaning fiscal policies.

UKIP – Peaked too early and likely bit-part player

Support for the UK Independence Party (UKIP) has eroded in the polls to around 14% from 16% at the beginning of the year. UKIP is on course to win only a couple of seats and is increasingly unlikely to play a decisive role in a new coalition government. Put differently, the cost of having to govern with UKIP, including demands for a 2015 referendum on the UK’s membership to the EU and scrapping welfare cuts, outweighs the benefit the Conservatives would derive from UKIP’s small number of parliamentary seats.

Olivier desbarres Political heavyweights having to consider alliances with smaller parties

Figure 5: Political heavyweights having to consider alliances with smaller parties


Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He is a former G10 and emerging markets economist, rates and currency strategist with over 15 years experience with two of the world’s largest investment banks.


Note 1: Average number of seats predicted by Election Forecast, Electoral Calculus, Elections etc. and May Seats do not add up to 650 as they exclude a number of smaller parties, notably Sinn Fein which is predicted to win five seats but typically does not vote in parliament.  Arrows represent increase/decrease in predicted number of seats.

Note 2: Size of discs is proportional to the average number of seats parties are predicted to win by Election Forecast, Electoral Calculus, Elections etc. and May  A bold line indicates a possible formal coalition arrangement; a dashed line indicates a possible informal, “confidence and supply” arrangement.


Fig 1 – Bank of England

Fig 2 –

Fig 3 – Election Forecast, Electoral Calculus, Elections etc, May and

Fig 4 – UK Parliament

Fig 5 – Election Forecast, Electoral Calculus, Elections etc, May and

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