The markets of the United Kingdom have had a rough past few weeks, as fallout from sovereign debt crises in the euro zone have negatively impacted British markets. In addition to this ongoing disaster, the British people went to the polls late last week in order to elect all 650 members of the House of Commons. As expected, the Conservatives trounced the Labour Party by obtaining 306 seats to Labour’s 258. However, this relatively small margin left the Conservatives far short of the 326 needed to form a majority, forcing them to form a coalition government with the Liberal Democrats (who won 57 seats in the election). After nearly a week of backroom deals and negotiations, David Cameron has become the new Prime Minister of the country with Nick Clegg the leader of the Liberal Democrats obtaining the role of Deputy Prime Minister (also see Britons Vote, UK ETF Loses).
Equity markets trended higher on the news, since many were growing concerned that the Liberal Democrats and Conservatives would have trouble reaching a compromise given their distance on the political spectrum. The main British ETF, the iShares MSCI United Kingdom Index Fund (EWU) was sharply higher on the news, pushing ahead by 1.1% in late afternoon trading. This comes as a sharp contrast to the fund’s recent performance; EWU is down close to 6.9% over the past two weeks and down 9.8% over the past month (see more EWU fundamentals).
However, the pound was not so fortunate; the Rydex CurrencyShares British Pound Sterling Trust (FXB) fell by close to 0.6% in midday trading. This fall comes as many Continental European countries expressed their displeasure with Britain’s reluctance to offer another 50 billion pounds in loan guarantees to help out indebted European nations. “The English are very certainly going to be targeted given the political difficulties they have,” said former French Europe Minister and current chairman of France’s financial services authority. “If you don’t want to show solidarity to the euro zone, then let’s see what happens to the United Kingdom.”
However, despite this threat, the new government could help to strengthen the pound in a number of key ways. The quickest way that the new government can boost the pound is by getting the British deficit under control. One of the policies that some are speculating the new government will impliment is a sharp increase in capital gains taxes. Some are forcasting that the rate could rise from 18% to 40% or more in the coming months, which could help to close the wide budget gap in the country. “A comprehensive spending review covering all Government spending is expected to begin within days and will report back late in the autumn,” writes Robert Winnett. “A review of Britain’s defence strategy, including the Trident nuclear deterrent, will also start.” Hopefully these new programs and taxes will get the British deficit under control and boost investor confidence in the struggling pound.
Disclosure: No positions at time of writing.