Election uncertainty takes toll on traders

Peel back the onion layers of uncertainty around Britain's election on Thursday, and another doubt emerges. The first of the known unknowns is which party will win the most seats, the very heart of political betting.

In many European countries the second uncertainty is standard: what coalition or minority government will emerge from the political horse-trading? British voters do not like political parties breaking solemn pledges, but if they want stable leadership they had better get used to it.

Implied volatility on sterling has already leapt amid worries about these two uncertainties (see chart).

The third uncertainty is perhaps the most difficult for investors, though. Even with full advance knowledge of which permutation of parties would end up on the front benches, it would still be hard to work out how the pound, equities and bonds will move.

Usually there is no problem: the Tories are good for investors, Labour is not. Market muscle memory may kick in with the results, with signs of a Tory-led administration pushing up prices, and Labour leadership hurting.

But for the longer run more discrimination is needed. Tory plans for a referendum on leaving the European Union mean another bout of uncertainty in 2017. If the build-up to the EU exit vote puts foreign investment on ice, it could weaken the pound, given the need for capital inflows created by the gaping current account deficit.

Equally, all the parties - even the Scottish Nationalists, according to independent analysis - are committed to more austerity, if at slightly varying levels.

There are a couple of places where the political rhetoric might match investment reality. As Michael Saunders at Citigroup points out, central London house prices will surely suffer under Labour's mansion tax. UK shares could have a tougher time under Labour, too, given the party's desire to boost worker's' income - or corporate costs.

But while voters should care about the details of the parties' plans, it is the economy and the budget deficit which matter to gilts and the pound. On these macro issues there is little to choose between the parties: Ed Miliband's 8'6"-high pledge stone is far weightier than the policies the Labour leader had inscribed on it.

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