London, 7 May 2010

The initial market reaction to the general election results (so far) confirms the view that a hung parliament was largely priced in. The drop in the FTSE is a follow through from yesterday’s weakness in the US – other European markets have fallen too - while the falls in gilts and the pound have so far reversed only part of their recent gains in response to the Greek crisis.

How the markets behave from here depends primarily on the prospects of decisive action to address the UK’s fiscal problems. Should the Conservatives form a working Government, then there will presumably still be a Budget within 50 days which might raise taxes and provide more details on the proposed cuts in spending.

If Labour clings on with the support of the Liberal Democrats, things are perhaps a bit less clear. Either way, though, we still think that the cross-party recognition of the seriousness of the problems means that some form of additional fiscal plan will emerge before too long.

Remember that, despite the spats about national insurance and efficiency savings, the main parties’ broad fiscal objectives are in reality very similar. But as we have warned before, the Greek crisis underlines the fact that there is little room for complacency.

The quicker the new Government, whoever it is, offers reassurance that it is serious about tackling the fiscal crisis, the better.

Ends --

Jonathan Loynes, Chief European Economist,  Ltd.