Election 2015 - how the markets will react on Friday

The markets usually fear change but no big majority at Westminster means no big changes - gridlock is good, it seems, but not for too long

Britain's financial markets are preparing for gridlock on Friday 8 May, the day after the tightest general election race in decades.

While George Osborne has warned of "fall out" Friday if Labour wins, the overriding feeling among traders appears to be that "gridlock is good" - in other words, if Britain wakes up to no strong majority for any party , there will be no big policy changes to fear.

It is quite likely that any dip in confidence from either a political vacuum or an undesirable alliance of political parties could lead to capital outflows and a fall in the value of the pound ...

It may be the case that the more uncertainty that arises over the result, and the more horse-trading is required to form a government, the more the pound will weaken. But when a government is formed, it is probably not a simple case of 'buy a Conservative win; sell a Labour victory' as far as the pound is concerned.

We could see some turbulence in the stock market in the next few weeks, particularly in the aftermath of the election if there is a hung parliament. However, the political machinations in Westminster have little bearing on the earnings potential of UK companies, which ultimately drives stock prices in the long term."

Such a government would probably bring additional uncertainty for businesses and investors, who will wonder how such a government will work in practice, and how long it will last. Such a government may struggle to find sufficient support for taking tough decisions, including continuing with or stepping up fiscal austerity."

We do not think that a minority or coalition government would be bad for the economy per se ...

The UK's strong economic fundamentals should ensure it fares well under all but the most divisive governments. That said, bond yields and the pound could move sharply as the next government is formed and the outlook for gilt issuance and official interest rates is clarified."

There is less to fear from a minority government than in the past: given limited fiscal policy divergence between the main parties, our economic forecasts are unlikely to change ...

Markets may be pricing in the risk of comparatively weaker UK governments the way that Wall Street looks at the US instance of divided government, assuming "gridlock is good": the notion that constrained governments are less likely to do much of anything, including pass legislation perceived as anti-business."

The continuation of a Conservative-led government would open the door to Brexit risk, which would likely negatively impact certain UK assets further down the road."

We expect markets to respond very differently to different electoral outcomes. Markets are likely to suffer the sharpest reaction to the announcement of an EU referendum. We expect the uncertainty and slower economic growth associated with such an announcement to result in a marked drop in UK equities, centred around concerns over the financial sector and other eurozone exporters. The Tory-Lib Dem majority scenario associated with this outcome would also likely pursue an ongoing tight fiscal stance which would likely add pressure on healthcare and support services sectors.

This would reflect both the uncertainty over the UK's future international role and a softer interest rate outlook (in turn reflecting softer GDP growth). A softer monetary policy outlook would also likely dominate the outlook for gilts. We consider it likely that gilt yields would fall in this scenario - although concede this may follow an initial, reflexive rise as some gilt holders fear a sell-off in international gilt holdings."

A Labour-led government will mean trouble for banks, utilities, property developers, betting companies and outsourcing companies. What is more, if the SNP get enough seats to enable them to pull the strings, then there is the further risk of an unstable government and possibly another Scottish referendum. A lack of adequate polling data in the UK means that it is not possible to rule out such an outcome at this stage, so caution on UK stocks - and sterling-denominated assets more generally - is warranted."

Around two-thirds to three quarters of FTSE 100 revenues are estimated to come from overseas. For a global FTSE 100 company like BHP Billiton, the UK election is a rather parochial event."

The main two UK companies to be affected by this would be Centrica and SSE, who together make up less than 1.5% of the FTSE All Share," said Khalaf.

We expect relatively tighter monetary policy to drive bond yields higher, although would envisage some of the yield increase to reflect a perceived rise in credit risk, particularly under the greater expected public spending in the SNP scenario.

Sterling would likely gain in the short run, both reflecting referendum-relief and the rising rate outlook. Faster GDP growth would also likely underpin domestic equities, although rising yields and sterling would neutralise much of this boost."

A strong government, be it Labour- or Conservative-led would probably tighten fiscal policy by around 2% of gross domestic product (GDP) in the first two years of the new parliament. This would give the members of the Bank of England's Monetary Policy Committee (MPC) considerable pause for thought. Take that away and the chances of an early base rate rise increase. The market is just beginning to appreciate this risk."