Photographer: Chris Ratcliffe/Bloomberg

Pound Traders Are Underplaying Risks of U.K. Post-Election Chaos

Currency traders are about the only people betting that chaos won’t erupt after the U.K.’s election.

They’re speculating that sterling volatility will peak in two weeks, the day after the May 7 vote, before subsiding over the next fortnight. With polls signaling no clear winner from the election, strategists and pundits say that’s when talks to form a government are likely to be in full swing.

“There’s a possibility that the whole thing only really gets going on May 8,” said Sam Hill, an economist at Royal Bank of Canada in London. “The potential for a very drawn-out period of negotiations to form a government is underpriced. The quick return to normality underplays the risk.”

A measure of anticipated price swings in the pound against the dollar two weeks from today has surged to 13 percent, the highest since September, with a three-week gauge lower at 12.7 percent, data compiled by Bloomberg show. The cost of protecting against volatility one month from now is just 11.7 percent. All three are about double their averages over the past year.

Stronger Pound

Spot trading in the pound also suggests dealers are sanguine about the political risks. Sterling has climbed 1.1 percent this week to $1.5128 as of 12:52 p.m. London time Friday, having touched a five-week high of $1.5146. That’s up from $1.4566 on April 13, the weakest level since 2010.

Opinion polls show the Labour and Conservative parties passing a narrow lead back and forth between them, suggesting that neither will win overall control of Parliament without the help of smaller parties. In 2010, it took five days to form the coalition government of David Cameron’s Conservatives and the Liberal Democrats.

“It’s very unlikely that we’ll have a government by May 8,” said Andrew Russell, professor of politics at Manchester University in northern England. “It’s entirely likely that we’ll have a prolonged period of interim government. I don’t think it will be Belgium proportions,” but “it will be longer than last time,” he said.

Laying Odds

With 326 lawmakers’ seats needed for an outright majority, bookmaker Ladbrokes Plc predicts the Conservatives will win 278 seats against 265 for Labour, 52 for the Scottish National Party and 28 for the Liberal Democrats. Peter Kellner, president of polling company YouGov Plc, said in March there was a “a real prospect of a messy result that makes coalition-formation exceedingly difficult.”

Five years ago, the result was less fractured, with the Conservatives winning 307 seats, Labour 258, the Liberal Democrats 57, and the SNP six. The pound fell 1.8 percent to $1.4833 on May 6, 2010, the day of the vote, before rallying 0.7 percent when Cameron entered his new office in Downing Street on May 11.

“The options market has been pricing in an election-risk premium for some time,” said Michael Sneyd, a foreign-exchange strategist at BNP Paribas SA in London. “However, it suggests we’ll get a repeat of 2010 with a short period of uncertainty and then a solution. It’s underpricing a protracted period of uncertainty as we play the game of who moves into Number 10.”

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