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Election will play key role in timing of first tightening in monetary policy

JUST over three months before the election, the outcome has never looked so uncertain. While recent opinion polls put Labour about three points clear of the Conservatives – which could give Labour a small majority – the opposition’s lead has been declining. If this continues, which it could do if recovering household wages improve perceptions of the government, the result of the election would be in the balance. And the rise in support for smaller parties and decline in votes for the major parties makes a coalition both more likely and potentially more difficult to broker.

Various configurations could arise after the election. First, we could see a return to a single-party government. This is often seen as a good outcome. But the logic might be questionable; both the Conservatives and Labour are pursuing policies that could produce market jitters: the Conservatives will hold an EU referendum, while Labour is proposing a mansion tax, higher top-rate income tax and less austerity. So the reduced uncertainty of a one-party government might not be matched by less uncertainty.

A second configuration might be a coalition with the Lib Dems, but there seems to be little appetite for a re-run of the past five years. If Labour turns out to be the largest party after the election, a Lab-Lib coalition/agreement seems the most likely way the Lib Dems could be king-makers. While the coalition has worked over the past five years (in producing a stable government), Lib Dem policies seem more closely aligned with Labour. Even if the Lib Dems are involved in the next government, they may be offered few key cabinet posts if their dwindling electoral support is translated into fewer seats in parliament. This, of course, may make negotiating a coalition with the Lib Dems all the more difficult.

Third, if there were a sizable rise in support for peripheral parties at the expense of the current largest three, parties other than the Lib Dems might be sought to form a coalition. Labour/SNP or Conservative/UKIP could be feasible permutations, though this would involve concessions on Scottish devolution and the timing of an EU referendum/immigration, respectively. If the SNP takes more Westminster seats than UKIP thanks to its more concentrated support north of the border, this would make a Labour/SNP coalition likely. A government involving both the Conservatives and Labour seems unlikely.

But a hung parliament might not lead to a coalition. Depending on how many seats short of a majority the biggest party is, a minority government could be run, though this would require the support of other parties and could be unstable. Indeed, Harold Wilson’s 1974 minority government lasted just a few months, and the Lib-Lab pact in the late 1970s lasted a year. A minority government would likely end up with fresh elections – following a vote of no confidence or a repeal of the fixed-term parliament law introduced by the current coalition.

The general election is not the only key event for the UK in the year ahead. Another issue relates to the first tightening in monetary policy. The election could play an important role here. A less austere government may increase the likelihood that the Bank raises rates later this year. The timing of the election in early May has probably reduced any risk of a rise in rates before the middle of the year – it may be difficult to deliver during the election campaign, during a period of uncertainty when the make-up of the new government may not yet be known, or while waiting for a new government’s emergency Budget. And if the Bank has waited until then to raise rates, why not wait until August? That is when the Bank will be publishing the minutes of its meeting and the Inflation Report at the same time as its policy decision for the first time. The accompanying press conference would provide an opportunity for Mr Carney to put some colour on what would be the first rate rise in eight years. ?

George Buckley is UK chief economist at Deutsche Bank 

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