Markets could drive timetable in UK hung parliament

Britain's opposition Conservative Party leader David Cameron (L), Liberal Democrat leader Nick Clegg and Prime Minister Gordon Brown (R) stand on stage after the third and final televised party leaders' election campaign debate in Birmingham April 29, 2010.

LONDON (Reuters) - Already jumpy because of the Greek crisis, markets could swiftly punish sterling if they sense policy paralysis after Thursday's parliamentary election.

Some London trading desks will be manned overnight as results come in, with gilts traded from 1 a.m. local time (0000 GMT). Some Asian currency dealers will also be watching results in the early hours of Friday.

If political parties need to negotiate a coalition, the clock will be ticking. British politicians are more accustomed to one party having a commanding majority.

"They do not have to agree on everything, just to work together," said Eurasia Group analyst Wolfango Piccoli.

"The maximum time horizon would be a week, but they would need to reassure markets over that time. The key thing will be managing expectations."

If the opposition Conservatives fail to win a majority but are comfortably the largest party -- for example with more than 300 seats in the 650-seat lower house -- then they are seen likely to try to rule as a minority, probably with the support of Northern Ireland's Ulster Unionists.

Markets will be jumpy on Friday if a coalition seems necessary, but might be willing to offer a day's grace, particularly if policymakers make reassuring sounds about a willingness to work together.

But if by Monday, May 11 no government has been formed and speculation is turning to new elections or weeks of horse-trading, worried investors may head for the doors as the politicians play for power. That in itself could call time on the negotiations.

In a real sterling emergency, the Bank of England would have the option of raising rates on Monday at its monthly meeting, delayed from this week by the election. But few see that as likely.

ALL ABOUT SPEED

A growing number of analysts and financial houses suggest a broad-based coalition might be more willing to push through painful cuts than a fragile majority -- although most still say an outright Conservative win would be best for markets. The issue is speed, given market nerves.

"It is quite possible to suggest that a coalition emerging from a hung parliament could push through fiscal consolidation faster than a small majority Conservative government," said David Owen, managing director and chief European economist at Jefferies.

"The question is whether markets would give it enough time."

Sterling and gilts could also benefit from Greece, rising against the euro on European troubles and shrugging off issues at home -- although the FTSE would likely track global market sentiment and continue to suffer the Eurozone's woes.

There are multiple scenarios as to how coalition negotiations could play out. Labor Prime Minister Gordon Brown, Conservative leader Cameron or even Liberal Democrat Nick Clegg could all have a chance of the top slot, or an internal Labor coup could usher in new contenders.

The Liberal Democrats could form a coalition or provide external support to a minority government.

None of those options would necessarily terrify investors. Indeed, who emerged as finance minister from such negotiations might ultimately prove more important for market credibility.

A Reuters poll of economists showed Conservative business spokesman Ken Clarke their favored choice, followed by Labor finance minister Alistair Darling and Liberal Democrat finance spokesman Vince Cable. Conservative finance spokesman George Osborne, often accused of inexperience, was fourth.

The greatest market risk might follow any emergency post-election budget. If that failed to convince and prompted negative moves from credit ratings agencies, it could prompt a much wider sell-off.

"The absolute worst thing for a new government would be a ratings downgrade after the budget," said Eurasia Group's Piccoli. "I don't think it would cause the government to collapse, but it would be terrible for its credibility and could prompt another reshuffle."

(Editing by Andrew Roche)