U.K. Risks 1974 Redux as Splintered Votes Hurt Stability

The outcome of the next general election risks leaving Britain looking more like it did in the early 1970s than it does today.

As Prime Minister David Cameron’s Conservatives meet for their last convention before the May 7 election, pollsters are forecasting no clear majority for either main party. That raises the prospect of a so-called hung parliament, a deadlock last seen in 1974 that led to an unstable government reliant on opposition votes to pass laws and a ultimately second election.

“We’re pretty certain it’s going to be a hung parliament,” Joe Twyman, head of political and social research at polling company YouGov Plc, said in an interview. “The type of coalition will determine how strong that bond is and whether we get another 1974. It’s pretty likely we could have two general elections in a 12-month period, and who wants that?”

A messy election adds to the unsure constitutional fallout of this month’s Scottish independence referendum and the uncertainty caused by the ongoing tussle over the U.K.’s future in the European Union. Taken together, those challenges pose risks to investors for the foreseeable future.

“The U.K. political landscape is going to remain in a state of flux,” Giacomo Barisone, senior vice president at ratings company DBRS Ltd. in London, said in a phone interview. “The combination of a likely lasting Scottish independence movement, the uncertainty surrounding the 2015 elections, and the non-negligible risk of a referendum on U.K. exit from the EU in 2017; all these factors point to political risks in the U.K. remaining elevated well beyond the referendum.”

Tory Defections

A reminder of those risks was delivered on the eve of this week’s Conservative annual conference in Birmingham, central England, with the defection of a second Tory lawmaker to the U.K. Independence Party, the anti-EU force that’s positioning itself as the kingmaker in next year’s election.

The desertion of Mark Reckless to UKIP, which won European elections in May though still holds no British parliamentary seats, foiled Cameron’s attempts to focus his party on formulating a plan of attack against the main opposition Labour Party for next year’s election and instead drew attention to its vulnerability on Europe and on immigration. Cameron is due to address the conference tomorrow.

A poll by Tory upper-house lawmaker Michael Ashcroft yesterday put the Conservatives and Labour led by Ed Miliband level-pegging on 32 percent support, with UKIP on 17 percent and Cameron’s Liberal Democrat coalition partners backed by 8 percent of respondents. Ashcroft questioned 1,000 adults Sept. 26-28. No margin of error was specified.

Deloitte Survey

The rising popularity of UKIP, a party committed to leaving the EU, and the consequent toughening Conservative stance on membership of the 28-nation bloc is forcing investors to consider the possibility that a referendum pledged by the Tories for 2017 may not just happen, but result in an exit. The Conservative-supporting Daily Telegraph newspaper cited Cameron in a front page article yesterday as saying that he’d be prepared to campaign for an EU exit if it wasn’t in the country’s interests to stay.

The proposed EU referendum and the general election rank before deflation, the weakness of the euro area and higher interest rates as risks to U.K. business, according to a survey of chief financial officers conducted by Deloitte. Deloitte surveyed 118 CFOs of FTSE-350 companies and other large private U.K. firms between Sept. 8 and Sept. 22.

While executives said risk had abated since Scotland voted on Sept. 18 to remain part of the union, the fallout may still prove a thorn in the British government’s side. The pro-independence camp gained 45 percent of the vote, and the promises for the transfer of more powers to Scotland made by the government to secure a “no” vote has led to calls by some English lawmakers for similar rights south of the border.

SNP Surge

Membership of the Scottish National Party that runs the semi-autonomous administration in Edinburgh has more than doubled to more than 65,000, with 39,000 new members joining in the week after the referendum. This raises the prospect of the SNP gaining an extra 20 seats in the election, on top of its six seats currently and further complicating the result, according to Peter Kellner, the head of YouGov.

In 1974, an inconclusive election in February led to a minority Labour government and a second national ballot in the fall. Conservative Prime Minister Edward Heath resigned after trying to set up a coalition with the Liberals, led by Jeremy Thorpe, before being replaced in Downing Street by Labour’s Harold Wilson.

The Conservatives won the popular vote in the February election, though Labour took more seats -- 301 to 297. The Liberals won 14.

Winter of Discontent

Heath spent much of the four days after the results were announced trying to persuade Thorpe that they could govern together before finally going to see the queen to resign. Thorpe demanded that Heath be replaced as prime minister and wanted a promise to make the electoral system more representative. The Conservatives rejected both demands.

Having ended a series of strikes that had blighted Heath’s final months in power, Wilson then called a second election for October. He won, but with 319 seats, a working majority of just three. Through the course of the 1974-79 Parliament, that majority was whittled away by defections and by-election losses. A prolonged spell of strikes known as the Winter of Discontent culminated in a March 1979 no-confidence motion that Wilson’s successor, James Callaghan, lost by one vote, precipitating the election that brought Margaret Thatcher to power at the head of a Tory government.

Economic Health

The relative health of the U.K. economy, which is forecast by the International Monetary Fund to grow 3.2 percent this year, remains a key difference to the dark days of the 1970s.

Britain’s economy grew a faster-than-estimated 0.9 percent in the second quarter, the Office for National Statistics said today.

The yield on U.K. government bonds was little changed at 2.45 percent as of 11:29 a.m. London time.

“Britain is the fastest growing, most job-creating, most deficit-reducing of any major economy on earth,” Chancellor of the Exchequer George Osborne told Tory delegates in Birmingham yesterday. During the past four years of financial and economic crisis, “Britain has been the lantern in the storm,” he said.

That doesn’t mitigate the risk of political instability that underlies the U.K. going into an election year, as the shifting sands of UKIP popularity combine with the SNP’s victory-out-of-defeat after the referendum to muddy the outlook.

“Those days of decisive, first-past-the-post election outcomes might be over, at least for the time being,” Kellner said in a statement. “If the SNP remain strong in Scotland, and UKIP can put down roots in parts of England, then it will be only a matter of time –- next year? 2020? 2025? –-before the business of creating a viable government in London becomes a great deal more complicated than it has ever been before.”

Before it's here, it's on the Bloomberg Terminal.