The polls have closed and the votes are counted on what has been one of the more surprising British parliamentary elections in history.  The Conservative party has emerged with a narrow effective majority in the United Kingdom; the Scottish National Party has an overwhelming majority in Scotland.  Only one of these two outcomes was expected.  The Conservatives were supposed to outperform Labour, but not by such a wide margin and never at such a huge cost to their Liberal Democratic coalition partners.  By contrast, the Scottish vote was expected, although many pollsters imagined that tactical voting would prevent the SNP from emerging with so many seats.

The market response to this outcome was positive.  The pound strengthened against both the dollar and the euro; share prices on the London Stock Exchange surged upwards.  Gilts also benefited, although the effect is smaller because interest rates are already near historic lows.  Nevertheless, this euphoria is likely to be short lived.  Much of the business community will celebrate a return of Conservative economic stewardship.  They will also be pleased that the Conservatives have an opportunity to govern without a major coalition partner (although, in fairness, the last coalition was more successful than most imagined in 2010).

Once the positive shock of the news has dissipated, however, the markets are likely to look at the medium-term agenda.  That is where uncertainty looms largest.  The two big questions are how SNP supporters will respond to their victory as they prepare for the 2016 elections to the Scottish Parliament and how David Cameron will prepare for an in-or-out referendum on European membership while maintaining good relations with a rebellious back bench.  Neither question has an obvious answer.  Worse, the two factors are likely to interact.  A resurgence of Scottish nationalism is going to spark a reassertion of ‘Englishness’, as is the presence of so many SNP members of parliament in Westminster.  And a heated debate on Europe is going to underscore the difference in attitudes north and south of the English-Scottish border.

What follows is only speculation — but none of it augurs well for medium-term business sentiment about the United Kingdom, either among firms within the country or from investors looking at the UK from outside.  The situation in Scotland is easiest to anticipate.  The SNP has shown little desire to return to a referendum on independence in the context of the national campaign; that reluctance will dissipate as SNP politicians begin to prepare for an intra-mural Scottish election.  Moreover, the Conservatives will anticipate this shift and try to head it off with discussion of some kind of devolution promise.  The question is whether they can offer enough to satisfy the Scottish electorate.  This will hinge on how much economic authority can be transferred from South to North.  It will also depend upon how much regulatory autonomy the Scottish Parliament can absorb without losing significant pieces of its financial services industry.  Both of these variables will be worrying from an investment perspective and so there will be good reason to defer new projects until the dust has settled.

Meanwhile, the conversation will turn to Europe.  This is going to be altogether more uncomfortable — not least because the public opinion polling has proven to be so unreliable.  The back bench of the Conservative party will push for a more aggressive renegotiation of Britain’s relationship with Europe.  A future Cameron government will be hard pressed to forge an appropriate response.  There is little appetite in the European Union to make concessions to the UK and few clear areas where a transfer of authority from the EU to Britain would have sufficient symbolic impact to assuage deep-seated Euroskepticism.  As a consequence Britain’s relationship with Europe will have a large question market hanging over it until a referendum can be held in 2017 — or avoided, if at all possible.  This will extend the period of uncertainty beyond the Scottish parliamentary elections.  If a referendum on Europe is held and the British electorate votes to leave, the effects will reverberate back in Scotland.

None of this is to say either that Britain will leave Europe or that Scotland will leave the UK.  Such developments are unlikely to result from a single electoral outcome.  Nevertheless, there is sure to be uncertainty surrounding the prospects for Britain’s future and such uncertainty will weigh on macroeconomic performance.

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