U.K. Vote Tie May Spur Sell-Off, Morgan Stanley Says

By Svenja O’Donnell

Dec. 1 (Bloomberg) -- An indecisive U.K. election result next year may prompt a sell-off in the British currency and bond markets, Morgan Stanley said.

A weak government, along with a record budget deficit and an uneven economic recovery, may lead investors to sell the pound and bonds, particularly if ratings companies cut the U.K.’s top debt rating, London-based equity strategists Graham Secker and Catharina Luebke-Detring said in a note yesterday.

“At the current juncture a lack of leadership from the top could have severe ramifications for foreign-exchange and bond markets, a sharp drop in sterling and rise in gilt yields,” Secker and Luebke-Detring said. “It is possible that we will see some U.K. corporate bond yields trade below gilt yields in 2010.”

Former U.K. finance minister Kenneth Clarke said last month that the opposition Conservatives, which have led in opinion polls, need to “work like mad” to avoid the prospect of a government which doesn’t win a majority of seats in Parliament. Britain’s next general election must happen by June 2010.

The Conservatives had support of 37 percent of voters, compared with 27 percent for the ruling Labour Party in a ComRes poll published in the Independent today. The result, if repeated in an election, would leave the Conservatives six lawmaker seats short of a majority, the newspaper said.

The pound rose 0.4 percent against the dollar today, and traded at $1.6454 as of 7:56 a.m. in London. The yield on the two-year U.K. government bond dropped three basis points to 1.163 percent.

Equity Forecast

The U.K. stock market may stagnate next year and the most likely scenario is the FTSE-100 Index slips to 5,000 from yesterday’s close of 5,191, Morgan Stanley said. There is a 30 percent chance that the index drops to 3,600 and a 30 percent probability that it jumps to 6,500, according to the bank.

U.K. growth prospects for the next five to 10 years are likely to be restrained, Morgan Stanley said, as the “NICE” decade of “Non-Inflationary Constant Expansion” described by Bank of England Governor Mervyn King gives way to a “GRIM” period where “Growth Really is Mediocre.”

“Grim is likely to be a fairly apt description of consumer sentiment as living standards are likely to fall,” the strategists said. The economy is likely to be hurt by a “weak” jobs market, “low” wage growth, higher taxes, faster inflation and a lack of credit, they said.

Morgan Stanley expects the British economy to expand 1.1 percent in 2010 and 1.6 percent in 2011, compared with rates of 1.9 percent and 2.1 percent in the U.S.

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net.