A sterling bet?

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Three Worries for Sterling Lovers

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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The British pound is having its best day in five years as early results in the U.K. election suggest a surprise victory for incumbent Prime Minister David Cameron. In defiance of opinion polls suggesting a split decision, voters appear to have forestalled weeks of wrangling over who leads the country. The political landscape, though, remains littered with landmines that may dent enthusiasm for U.K. assets in coming weeks -- including the prospect of Britain leaving the European Union and Scotland quitting the United Kingdom.

QuickTake Will Britain Leave the EU?

The pound has been on a tear against the dollar since an exit poll, released once voting concluded at 10 p.m. last night, suggested a clear victory for the Conservative Party:

Source: Bloomberg

As soon as the votes in his own constituency confirmed he'd kept his seat, however, Cameron repeated his pledge to hold a referendum by the end of 2017 on the U.K.'s membership in the EU (you can see the live election results here). While the anti-European U.K. Independence Party wasn't able to translate its roughly 12 percent vote share into more than one or two members of Parliament, there are enough anti-EU members of Cameron's own party to make it likely that the issue will stay on the front pages. Here's a chart showing weekly occurrences of the word "Brexit" in news stories collated by Bloomberg from more than 100 hundred media providers:

Source: Bloomberg

For the most part, business leaders hate the idea of Britain leaving the EU. An acrimonious two-year campaign carping at Brussels would likely bring out the worst in politicians, exposing ideological rifts in the ruling Conservative Party that run deep and deterring companies from making investment decisions. It's unclear how Britain's spurned allies on the continent would react; but with half of U.K. exports going to the EU, it seems unlikely that the economy would emerge unscathed. The Centre for Economic Performance suggesting a departure could wipe as much as 9.5 percent off gross domestic product on a worse-case scenario.

The more pressing domestic issue is likely to be Scottish independence. The Scottish National Party appears to have won all but three of Scotland's 59 seats, making it the third-biggest party in Parliament. Even though last year's referendum on whether Scotland should go it alone was defeated by 55 percent to 45 percent, government promises to devolve more autonomy may fall short of the SNP's demands for full control of Scottish finances, leading to renewed demands for a second vote.

Recall that the pound slid to a nine-month low in the approach to the September referendum as polls suggested the prospect of a messy break-up of the U.K. was a clear and present danger. Renewed bickering over the future composition of the nation, as an emboldened SNP argues that its overwhelming dominance of the Scottish political landscape gives it a fresh mandate, is unlikely to be good news for the pound.

Finally, there's the issue of U.K. political leadership. The Labour Party is likely to defenestrate its leader, Ed Miliband, for losing the election. The LibDems, meantime, will probably jettison Nick Clegg, blaming his term as deputy prime minister for their collapse to fewer than 10 seats from 56 before this week's vote.

That matters less, though, than the possibility that Cameron might decide he's had enough. He's already said he won't stand in the next election in five years' time. And the prospect of two years of infighting over Europe would dismay even the freshest of leaders. "All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs," the Tory politician Enoch Powell famously said. Cameron may be tempted to become the first Prime Minister in modern history to leave on a high.

The Conservatives have several viable leaders waiting in the wings, including Chancellor of the Exchequer George Osborne, Home Secretary Theresa May, and Boris Johnson, who easily won his seat and will do double duty as London Mayor until his term in city hall ends next year. Still, the prospect of a leadership battle may leave investors wondering who will actually end up leading Britain.

For financial markets, Thursday's election outcome brings the benefit of clarity rather than the discord of a hung parliament. Pound enthusiasts should be aware that there's still huge potential for further drama on the U.K. political stage. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Marc Champion at mchampion7@bloomberg.net