Events Overseas Matter More Than Election Votes

The dissolution of parliament last Monday, and subsequent television “debates”, means campaigning has officially begun ahead of the most uncertain election in a generation. There’s no easy way to summarise what might happen on Thursday May 7 – suffice to say that we’ll almost certainly see an indecisive hung Parliament.

The identity of the British government will then depend on frenzied negotiations that could leave the world’s sixth-largest economy in political limbo for weeks or even months. A prolonged struggle over power-sharing – which, as in 1974, might result in a second general election – could unleash big constitutional uncertainties as parties press their respective agendas. A resurgent Scottish National Party may demand another independence vote. We could even see a snap referendum on the UK’s European Union membership.

Such doubts are likely to unsettle investors as polling day approaches, knocking equity markets and delaying long-term capital spending. And, if we then end up with a Labour-led administration propped up by the SNP, that would alarm Britain’s creditors – given SNP leader Nicola Sturgeon’s determination to forge “a progressive alliance against austerity”.

Consider, also, that the UK is shouldering a huge external deficit of around 5.6pc of national income. If concerns escalate about an incoming profligate government, that imbalance could weigh heavily on the pound. Sterling is currently strong against the euro, recently hitting a seven-year high.

It’s increasingly fashionable, though, to argue the pound is overvalued – so much so that, if it started falling amid concerns spending might spiral as a result of post-election horse-trading, sterling could drop dangerously fast. In that case, there’s an outside chance the first interest rate rise since 2007 could be sparked by a need to defend the currency.

Along with the decidedly hazy domestic political outlook, this election is happening at a time of swirling international uncertainty too – not just potential eurozone break-up, but ongoing East-West tensions in Ukraine and escalating turmoil in the Middle East. That’s worth remembering because, for all last week’s focus on British party leaders – those already well-known and those less so – the post-election trajectory of the UK economy is likely to depend far more on events overseas than on votes cast in Britain just over a month from now.

While it’s widely assumed the Greek crisis will somehow be resolved, with the eurozone avoiding another systemic meltdown, that actually remains far from certain. The euro fell more than 11pc against the dollar during the three months to the end of March, the biggest quarterly drop since the single currency’s 1999 inception, as Athens has remained locked in often rancorous negotiations with its eurozone creditors.
The Left-wing Syriza-led government must reach agreement over further fiscal consolidation with eurozone finance ministers within weeks, or face bankruptcy. Last week’s resignation of a leading member of Bavaria’s CSU party, a coalition partner of Angela Merkel, was a warning to the German chancellor that Greece can be granted little slack.

Steely-eyed, Greek prime minister Alexis Tsipras responded last week by bringing Russia into these negotiations – as some of us have long predicted. Athens is now threatening to veto any extension to EU sanctions against Moscow (which it is legally capable of doing).

Some see that as outrageous behaviour, others merely as “geopolitics”. Whatever your view, Tsipras’s latest move has piled pressure on Brussels to comply with Greek demands, given America’s determination to maintain a united front against Russia.

The high stakes, then, and the strength of feeling on all sides, mean that reaching a deal is going to be tough. The finger-pointing, chest-thumping and related market lurches are likely to get a lot worse over the coming weeks – ahead of the UK general election. And if there is a Grexit, of course, that will spark major turmoil on global bond markets, amid speculation over which country might be next.

While a long way from prominent, the Greece crisis remains at least on the fringes of the Westminster news radar – not least as a renewed eurozone crisis is likely to further benefit Ukip, generating even more electoral uncertainty. But the ongoing drama that is Ukraine’s struggle to reach a deal with its international creditors has been almost forgotten, even though this showdown is even more ideologically charged than the battle being waged by Athens.

What’s more, if the talks go wrong, a Ukrainian default is just as capable of causing a systemic crisis that would spread across Europe, and beyond, upending the fragile global recovery. While Greece is suffering, the Ukrainian economy has lately been in agony, not least due to fighting and shelling in Eastern Ukraine that has seen thousands tragically lose their lives. Ukrainian GDP fell some 6pc last year and a similar drop is expected in 2015. Interest rates are up at 35pc, and inflation isn’t far behind. Kiev is now embroiled in a complex negotiation with international creditors – both private and public sector – before talks can start on a restructuring deal to plug a $15.3bn (£10.3bn) funding gap.

One sticking point is a $3bn Ukrainian bond held by Russia, which could, if Moscow chooses to trigger a clause in its contract, fall due for early repayment. That would jeopardise Ukraine’s $17.5bn loan from the International Monetary Fund, to say nothing of provoking the ire of an increasingly belligerent US Congress, which is loathe to be associated with any Western-sponsored bail-out programme that ends up channeling cash to Russia.

Again, there is a significant probability these negotiations could go wrong, leading to a sovereign default. When markets are nervous, default in places that seem far off can suddenly become extremely significant. It was Thailand in 1997, after all. And few people saw that coming.

The good news is that the British economy grew at its fastest pace for nine years in 2014, with new figures last week showing a 2.8pc expansion. While strong economic data should benefit the Conservatives, I’m not sure it does. If floating voters sense we’re out of the economic woods, they might feel the UK, once again, can “afford” a Labour government. It may be that renewed signs of crisis, not least turmoil abroad, benefit the Tories more than signs of stability.

It’s perhaps ironic, then, that one of Labour’s most prominent donors, the businessman John Mills, has written a thoughtful and detailed pamphlet, to be published by the think-tank Civitas later this month, which suggests that crisis might be just around the corner.

“The danger now is that there will be little or no growth in the West – at least measured by GDP per head – for the foreseeable future,” Mills says. “If that happens, the comfortable assumptions on which so high a proportion of our plans depend will be thrown into very serious disarray”.

We may be “getting closer than is often realised to a number of critical tipping points which, if they materialise, could reinforce each other to produce a much more vicious downward spiral,” Mills argues, “not only producing no growth but a major economic downturn”.

While I accept much of Mills’ analysis – that the UK recovery is extremely fragile, and we face significant systemic dangers, not least from our massive balance of payments deficit – I’m less sure about his remedy, which amounts to taking deliberate, sustained steps to competitively devalue the pound.
Having said that, Mills’ work is that rare thing, a thoughtful policy intervention in an election campaign that has already descended into trivia and theatrical slapstick.

And there’s still over four weeks to go.

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