The May elections could destabilise the political tradition of the United Kingdom and with it the future of the European Union as we know it. With only a few weeks away from the vote, a sustainable coalition is far from emerging, let alone a clear winning party. The uncertainty over the outcome could lead towards a hung parliament, where much effort is wasted on political bickering rather than leading the country. It is an unusual scenario for the UK, where the coalition between David Camerons Tories and Nick Cleggs Lib-Dems has been reduced to a theoretical exercise: it didnt take much for the current government to define a conservative stance. As The Economist puts it, 'Labour, which used to rule Scotland, could be reduced to a handful of seats there. Support for the Liberal Democrats, tarnished by a coalition government, has collapsed. Almost all the running has been made by three insurgents: the Scottish National Party (SNP), which wants Scotland out of Britain; the UK Independence Party (UKIP), which wants Britain out of Europe; and the Green Party, which wants hyper-capitalism out of both Britain and Europe. It is the biggest shake-up since the early 20th century, when Labour displaced the Liberals, the magazine writes.
Will political instability affect the country's economy with long term consequences? Not necessarily. Even in the most unstable scenario, a coalition is likely to be formed to run the country and fulfil the countrys basic needs in the short term. A greater risk is the impossibility of defining long term strategies which will translate into early elections. On economic policy, the conservative effort concentrates on debt repayment, as indicated by Chancellor of the Exchequer George Osborne in his last pre-election Budget law, including £12 billion in cuts. Labour's approach is to increase investment and foster growth. These two opposing lines of action will be hard to reconcile, should a clear majority not emerge from the May vote. The current government has results to show: 2.7% year on year growth, declining unemployment (5.7%) and buoyant house prices.
Underneath the UK growth hood lie many vulnerabilities, Alberto Gallo, head of macro credit research at Royal Bank of Scotland warns in a note to their clients. One of the largest structural deficits in the developed world (-4.2%), rising household debt (145%/income) and the collateral effects of easy monetary policy (inequality and reliance on a mobile, high net worth tax base). Regardless of the election result, some tough choices await the next government. Spending will have to decline substantially in the future, and so far no party has a plan that tackles the problem.
Less worrisome is the populist variable in line with the emergence of extremist parties scattered all over Europe. Nigel Farrages UKIP has seen their preference decline in the most recent polls, and in any case the British electoral system does not favour minority parties. Nevertheless, should UKIP win thirty seats, they could have a say on who will run the country. What really matters then is not how many seats Farrage will obtain, but rather how many he will subtract from Cameron. The most eurosceptic wing of the Tories could envisage a coalition with UKIP as an opportunity to set a prompt referendum on Europe, perhaps ultimately leading to Britain leaving the European Union. Talking Brexit is no longer taboo. Nile Gardiner, director of the Margaret Thatcher Centre for Freedom at the American conservative think-tank the Heritage Foundation, writes openly on the European Parliament magazine that an independent Britain, freed from the shackles of EU regulation and endless interference from Brussels, can only result in a stronger partner for the United States on the world stage. A vote on Europe may have a stronger impact at an economic level, not only for the UK, but also for its European partners, while less concern seems to be placed on the consequences for Gilts. The UK public debt remains interesting for international investors, regardless of the electoral outcome. We can expect an immediate reaction on Treasury bonds, but this would not undermine the UK debt management offices funding strategy.
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