Uncertainty hung parliament – impact on UK financial markets

By | May 7, 2010

expectationTwo huge stories engulfed UK financial markets overnight. The first was that early yesterday evening, British time, the Dow Jones index fell nearly 10%, before rallying to end “only” 350 points down on the day. Then in the early hours of today, despite scepticism over the exit polls’ prediction of a hung parliament, it became clear that the Tories had failed to secure an overall majority.

As might be expected, UK financial markets have responded badly to this uncertainty. Sterling is significantly weaker against the both the dollar and the euro, the stock market has fallen and bond yields have risen.

So what is the main driver of all of this?

The fall in the US market can be mainly attributed to continued problems in Greece. But, when this situation was escalating last week, there was very little reaction in British markets. The all-important Credit Default Swap prices – which indicate how risky investors think British Government debt is – stayed steady, as did the £/$ exchange rate and bond yields. The implication is that the markets currently consider Britain to be currently fairly well insulated from the growing problems in southern Europe.

So, is today’s market slide primarily a response to the election results, rather than, as some may believe, the unfolding crisis in Greece? There is certainly evidence for this. Bond yields have risen since markets opened at 1am and the main fall in sterling happened around 6am – both long after the US market had closed. Also, if this is primarily a Greek-driven problem, why has sterling been so weak against the Euro this morning?

In light of the evidence, my view remains that it’s what is happening domestically, rather than what is happening internationally, that is primarily driving UK financial markets today.

Let’s hope the politicians get the uncertainty resolved quickly.

About Mark Freeman

Mark joined the School of Management in 2006, following previous full-time academic appointments at the Exeter Centre for Finance and Investment (University of Exeter) and the University of Warwick. He has held visiting academic positions at the Kellogg Graduate School of Management (Northwestern University), the University of California, Irvine, and the University of Technology, Sydney.

Before becoming an academic, he worked as an equity research analyst specialising in the brewing and distilling industries for stockbrokers Savory Milln and James Capel, in London. He also has corporate finance experience with United Distillers in Scotland.

Specialties: Economics of climate change, Long term funding of nuclear power, Pension funds - long term deficits