Hung parliament could be huge blow to fragile economy

The prospect of a hung parliament suggests a number of coalition permutations.

There is talk of a LibDem deal with Labour but not with Gordon Brown as prime minister. A Lib Dem-Tory administration might see George Osborne denied the chancellorship and Vince Cable installed in his place. But common to almost all scenarios is the strong likelihood of electoral reform moving rapidly up the political agenda. The prospect that cannot be dismissed is that the party coming in third in terms of share of the national vote could still end up with the premiership. For millions of voters that would only be acceptable – if at all – as a most temporary outcome.

The Liberal Democrats have been anxious to give assurances that a hung parliament need not be divisive nor indeed the cause of apprehension in financial markets. But many businesses in Britain are concerned that a prolonged period of haggling would unsettle the pound and bring forward a rise in interest rates. Given the frail nature of the recovery, a rise in rates earlier than domestic economic conditions justify would be an election loser.

Business itself would not be helped by a prolonged period of uncertainty. The possibility of a hung parliament would kindle speculation about the timing and nature of a second election. It is this uncertainty that would lead many businesses to hold back from recruiting and put investment plans on hold until the outcome of a second poll is known.

As matters stand, the Centre for Economics and Business Research has calculated that a hung parliament could cost consumers as much as 5,000 a year due to the higher cost of mortgages, petrol prices and holidays abroad. It posits a rise in interest rates to 3.5 per cent from today's ultra-low level of 0.5 per cent, triggered by a fall in the pound. The British economy, it warns, could take a sharp nosedive over the next six months. While such an outcome is by no means assured – markets are unlikely to rush into early judgment on the outcome – party leaders will be strongly advised by the Treasury of the risks of prolonged uncertainty and the need for early resolution in forming a government.

One solution might be a form of cross-party government until a second election is held within a year. But that may prove easier said than done if the negotiations involve a change in the voting system and an insistence that the new system is in place for a second general election. This would also suggest that early action on the budget deficit and government debt would take second place: such a perception would invite the very trouble that businesses most fear.