SCENARIOS-Impact of Lib Dem surge on British election

LONDON, April 26 (Reuters) - Britain looks set for a hung parliament where no individual party has overall control for the first time since 1974, following a surge in support for the normally third-ranking Liberal Democrats.

Lib Dem leader Nick Clegg has seen his party soar in popularity since he outperformed Prime Minister Gordon Brown and Conservative leader David Cameron in the first of three U.S.-style television debates ahead of the May 6 election.

Below is a look at a few of the scenarios that could play out after polling day:


* Probability: unlikely

The Conservatives need a lead of more than 10 percentage points in the overall vote to secure a simple majority in parliament, according to analyses of Britain’s skewed electoral system.

But they have not enjoyed such a lead in opinion polls since January, while the recent spurt in Lib Dem support pushes outright victory further from their grasp.

Barring a last-minute swing back to the Conservatives, a huge parliament looks the most likely outcome.

* Likely market reaction: an outright Conservative majority would probably be broadly welcomed by markets currently expecting a hung parliament, with sterling GBP= the main beneficiary but the rally filtering through to government bonds and stocks.


* Probability: possible

If the Conservatives fall short of a parliamentary majority but gain the most seats, they will be in pole position to form the next government.

Clegg has said he will push for progress on four “fundamental reforms”: fairer taxation, reform of the economy, improvements in primary education and a more proportional voting system.

While Cameron might be able to strike a deal on the first three, he has said he does not want to change the voting system.

That could prove the dealbreaker for the Lib Dems, leaving Cameron the option of trying to run the country at the head of a minority administration.

* Likely market reaction: this would depend on how survivable the minority Conservative government would be, and how seriously it looked set to tackle the budget deficit, equivalent to 11 percent of GDP. Some analysts argue a Conservative minority government would still be enough to produce a small sterling rally in its own right. Others worry it might struggle with its internal differences over Europe in a similar manner to John Major’s Conservative government before 1997.


* Probability: possible

Clegg has distinguished himself from previous Lib Dem leaders, who would never have done a deal with the Conservatives, by portraying himself as open to a deal with either of the main parties.

The key to a deal with either side would be agreement on the Lib Dems’ four priorities. Labour is more likely to shift some ground on voting reform, and is already promising minor changes, although they fall short of Lib Dem demands.

The Lib Dems could prop up either Labour or Conservatives in a deal short of a coalition, in return for concessions on its other demands if agreement on voting reform cannot be reached.

* Likely market reaction: the most important issue for markets will be how quickly such a deal is worked out. If it becomes clear the Lib Dems will not block a budget, markets will be reassured. If horsetrading continues for a prolonged period of time, markets will sell off.


* Probability: unlikely

Clegg has indicated he would not support Labour if they won the most seats in a hung parliament but came third in terms of votes. He says it would be indefensible for Labour to try and remain in power in such an outcome, which would be possible given Britain’s first-past-the-post system and the concentration of the Labour vote in urban centres.

But that objection does not create a constitutional obstacle to Prime Minister Gordon Brown trying to remain in power as a minority goverment, even without Lib Dem support.

The Lib Dems agree with Labour plans to delay spending cuts to tackle the deficit until 2011, so could potentially support a Labour budget.

* Likely market reaction: the main market worry would be how survivable a minority Labour government would be, and how much influence trade unions -- and MPs allied to them -- would have. Investors would fear a minority Labour government would be slow to tackle public spending, boosting worries of a credit rating downgrade and wider market sell-off. But prompt action -- or even simply promises of action -- might reassure them.


* Probability: unlikely

As a centre-left party the Lib Dems are closer to Labour than the Conservatives. Labour and the Lib Dems worked in coalition for eight years in the devolved parliament in Scotland between 1999 and 2007, so there is precedent for an alliance.

But Clegg has been highly critical of Gordon Brown throughout the campaign, and is opposed to many Labour measures such as personal identity cards which Lib Dems argue encroach on civil liberties. That makes a formal alliance politically embarrassing and potentially impossible, at least as long as Brown remains leader.

There are also procedural obstacles. A formal coalition would have to be approved by a special assembly of Lib Dem members, whose approval cannot be assumed in advance.

* Likely market reaction: opinions are mixed. Some in the market view a Lib-Lab coalition as probably the most survivable and stable coalition option, possibly capable of drawing on enough broad-based support to push through tough deficit-cutting measures. That would be generally market-positive.

Much would depend on the choice of Chancellor. Lib Dem finance spokesman Vince Cable, a former chief economist for Shell, is widely respected and came ahead of the other two main party’s finance minister choices in a Reuters poll last month. But his tough line on banks might impact their shares.


* Probability: very unlikely

Although Clegg has positioned his party as neutral between Labour and Conservatives, he has not carried his members or members of parliament with him. Most would be very uncomfortable joining a formal alliance with the Conservatives and such a move could split the party.

Again, the special assembly required to agree a coalition would be very unlikely to vote in favour -- unless, perhaps, full proportional voting was promised. But that is a concession the Conservatives appear equally unlikely to offer.

* Likely market reaction: some analysts argue this coalition formation is likely to address the deficit faster than a Lib-Lab pact, which would be positive for markets. However, others argue it might be particularly unstable, which would be negative. Among other factors, a Lib-Con pact would have to reconcile deeply competing positions on Europe.

Reporting by Tim Castle and Peter Apps, editing by Mark Trevelyan