Between the lines: Beware the 1974 spectre of two elections and three budgets

FOR anyone in business and finance, this is shaping up to be a turbulent year, with two budgets and a general election ahead. But might it be much worse – that is, two general elections and three budgets?

A shrinking lead for the Conservatives in the opinion polls is raising the odds on a hung parliament at Westminster.

It is a prospect that will compound business anxieties about the outlook for sterling and interest rates. As if the worrying muddle in the Conservative ranks about the extent of any immediate action on the budget deficit was not enough, the spectre of a hung parliament, with horse-trading and jockeying to form a working coalition, makes any bold and decisive action on the deficit an unlikely prospect.

But that may not be the half of it. Given the potential for a choppy financial market reaction to no clear mandate at Westminster, another spectre hoves into view: a second budget later this year (or third, counting Labour's pre-election budget in March) followed by a second election at the year-end or early next year to break the impasse.

Impossible? Despite the longest recession on record and an unpopular Prime Minister, the Conservative opposition lead in the polls has been crumbling.

More opinion polls over the weekend showed the Conservative lead over Labour continuing to slide.

The last four polls put the Conservative lead at well below 10 percentage points. Taking the last five polls, the average lead is just below 10 points, the lowest since early 2009. By contrast, last October the Conservatives were 14 points ahead of Labour in voting intentions.

These polls, says a Citigroup analysis, imply a fairly high chance of a hung parliament. The Conservatives need to be 8-10 percentage points ahead of Labour in votes cast in order to get a majority at all in parliament. To get a comfortable majority (40-50 seats) the Conservatives probably need to be at least 12 points ahead.

Citigroup's Michael Saunders says: "The key market issue is the interplay between political stability and fiscal sustainability. In the event of a hung parliament, there is likely to be intense and unresolved uncertainty over the UK's ability to announce and actually implement over several years (Citigroup italics] enough fiscal consolidation to return to a sustainable fiscal path. Gilts remain highly vulnerable to such risks."

The last occasion on which Britain had a hung parliament and two elections and three budgets in one year was 1974 – and it is not a cheerful scenario to revisit. The economic and political dynamics were much different, of course, and close parallels cannot be drawn between then and now. But a revisit to the 1974 crisis does strike some ominously familiar notes.

The year began with the pound on the skids, falling in mid-January to a record low against the dollar of $2.18. The FT 30 share index plunged to a seven-year low of 301.7 on a combination of appalling trade figures and fears over the miners' strike, while gilt edged stock hit a new record low, with yields topping 13 per cent.

The government called a general election and expectations of a Conservative victory carried the FT 30 back up to 337.8 by the eve of poll. The shock result, with Labour five seats ahead of the Conservatives but with no overall majority, triggered a sharp relapse in the market. Harold Wilson was back in Downing Street. The miners' strike was quickly settled but any relief was soon snuffed out by Denis Healey's budget at the end of March, which raised income tax by 3p. The top rate was raised to 83 per cent and to 98 per cent for investment incomes. Corporation Tax was raised to 52 per cent.

A deepening secondary banking crisis and worsening inflation, which played havoc with company profit margins, sent shares sliding further. A mini-budget on 23 July took VAT down from 10 per cent to 8 per cent, but did not impress the market. By end July the FT 30 was down to a 16-year low of 236.4.

A second election on 10 October saw Labour returned with a majority of three. A mid-November budget revealed spiralling debt of 6.3 billion (up from a March forecast of 2.7bn) and the FT 30 ended the year 53 per cent down at 161.4 – the worst year ever for the market. Gilts now yielded 17 per cent.

The past, of course, is a different country. But hung parliaments – particularly when combined with the worst budget deficit in peacetime – suggest a potentially toxic combination in the months ahead.