The Other UK Spectacle: Elections and Referendum

The Royal Wedding (and Kate Middleton) are capturing the world's attention, but there is another event around the corner that may be more notable for investors. On May 5th the UK will hold its first referendum since the mid-1970s. It is on the general voting style and it will likely keep the current "1st past the post" system. On the same day there will also be election in almost 280 local authorities and election in the devolved administrative areas--Wales, Scotland and Northern Ireland.

The is no direct implications from the the elections or referendum, but there could be indirect consequences that are notable for medium term investors. It could weaken the political environment and undermine the policy climate. This is all the more important because of the serious straits the country is in. Its debt/GDP ratio is worse than Spain and Portugal. The economy has essentially stagnated over the past six months.

However, there has been political peace which has allowed for decisive policy. What is called a coalition government in other countries is what is called a hung parliament in the UK and the Tory/Lib-Dem marriage has been surprisingly robust in the first year. The debate over the referendum has soured the relationship between the couple and has gone considerable further than the tuition increase debate. It is not immediately clear that a rapprochement will be possible. Political observers in the UK seem mixed.

The referendum and local elections, that the Lib-Dems are expected to lose many seats, exposes a fundamental weakness in the Lib-Dem challenge. The rank and file appear to be to the left of the leader N. Clegg and by going into the marriage bed, the Lib-Dems have arguably eroded their separate identity.

The Lib-Dems may be the big loser in the referendum and local elections. This may leave it licking it wounds and eager to pick a fight with the Tories to demonstrate its independence. This may leave the government in a unenviable position as attention turns to reforming the National Health Service and other controversial issues.

Separately, the Bank of England meets next week (as does the ECB and RBA). No change is expected. This is the hawk Sentance's last meeting and no doubt he will persist with his dissent. The other dissenter Weale has acknowledged the economy is weaker than he had anticipated, but whether this translates into a changed vote may be a different matter. In any event, the market expects the BOE to remain on hold for at least a couple more months, while we think that the BOE has in effect suspended its inflation target and is reluctant to raise rates in the face of a weak economy and serious fiscal austerity.