Are the markets right to fear a hung parliament?

January 18, 2010

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-David Kuo is director at The Motley Fool. The opinions expressed are his own -

There is a well-trodden saying that markets hate uncertainty. Elections are inevitably uncertain, so until the votes in the next election are counted we cannot be certain which party will govern the UK.

Currently, there are suggestions that no single party may get sufficient votes to form the next government outright. It is true that the Conservatives have a strong lead over its rivals. However, with a first-past-the post voting system, it only takes a small swing away from the Conservatives to change the complexion of the next parliament.

But let’s look at the problem facing the next government, whatever its colour. It may be blue, it may be red or it may be some combination of red and yellow or blue and yellow. That said, no government can ignore the budget deficit of £175 billion and the national debt of some £800 billion.

Politicians may like to stick their finger in their ears or bury their heads in the sand and pretend the problem does not exist until the election is over. But creditors won’t forget. Following the election, the next government knows that there will be howls of anguish and squeaking of pips when taxes are increased and public spending is slashed.

No government, a hung parliament or otherwise, can afford to ignore its creditors. The alternative is an even heftier annual interest bill. The current annual interest payment is already a whopping £40 billion and could rise further.

So, does the market have a right to fear a hung parliament?

The answer is no. Britain will need to sort out its financial mess regardless of whether George Osborne, Alistair Darling or Vince Cable takes charge of Britain’s finances. The cuts in public spending will be severe and the tax hikes will be penal.

What is uncertain is who will reside at 11 Downing Street. What is not uncertain is that whoever resides at number 11 will have to dance to the tune of gilt investors. Failing to tax and mend could result in damaging the pound, which in turn will stoke inflation and push up interest rates.

Ironically, the stock market may continue to thrive while the UK’s electorate considers where to place their “cross” on election day. For most FTSE 100 companies, what is happening outside the UK is of greater relevance given that over 80% of their profits are generated abroad. The UK’s top 100 companies earn more in both the US and Europe than in the UK.

So, by all means ponder the hue of the next government. The outcome will have an impact on our daily lives but it is unlikely to affect the markets, which are more interested in global issues.

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