So far, investors have been relatively relaxed about what UKIP might mean for their portfolio of UK assets. Their arguments run as follows:
1) Britain’s electoral system means they will never have more than a couple of MPs
2) The Conservatives will tack to the right to see off their threat, and as the Tories are already offering a referendum on Europe, that risk doesn’t change
3) The polls suggests Labour or Labour plus Lib Dems would be the most likely government anyway, and Labour aren’t offering a referendum, so that risk doesn’t change either
Ergo, they conclude, UKIP might be an interesting sideshow about the rise of Eurosceptic parties in Europe, but it remains a sideshow. One that doesn’t affect their investment decisions into the UK. One for the political geeks to ruminate upon.
That would be an error. The most important result last week wasn’t the fully anticipated win for Tory defector Douglas Carswell in Clacton but the extremely close result in the allegedly safe Labour seat of Heywood and Middleton. Just 617 votes prevented UKIP from winning. Sure, turnout was just 36%. Sure, it’s a by-election, and weird stuff can happen. But politics is all about momentum, and with the General Election only 7months away, UKIP are currently the horse taking the lead as they gallop around the final bend. The government are trying to slow that momentum by dragging out the date for the next UKIP defector by-election. The Tory candidate for Rochester & Strood will be chosen by postal vote, so that, in a sop to the libertarian motivations of UKIP voters, ‘the people can decide’. Handily, this also delays the process. The by-election is expected to take place towards the end of November, when a cynic might suggest that voters have Christmas shopping rather than protest-voting on their minds.
Whoever wins the by-election, the wheels are already in motion for UKIP to disrupt next year’s General Election. Why?
1) There could be more defections ahead, if MPs feel their seats are at risk. A Survation poll puts UKIP on 25% of the vote (!) and the two main parties on 31% each, which would translate into over 100 UKIP seats. Now, that poll also showed that people trust Nigel Farage the most of all the party leaders to fix a shelf, so you might dismiss it as a rogue poll, but it shows just how strong their momentum is. And it’s not just Conservative MPs. As this detailed analysis by the Fabian Society shows, 16 Labour seats are on the critical list for losing to the Conservatives as a result of UKIP.
2) Given the declining support for the two major parties, and the risks of another hung parliament, both Labour and Conservatives have to consider how, if at all, they might work with UKIP. Conservative backbenchers are openly discussing an electoral pact with UKIP, “Otherwise, the only thing we manage is mutually assured destruction.” (Jacob Rees Mogg). Nigel Farage has announced that a snap July 2015 EU referendum would be his price for propping up a minority Tory government, and a referendum itself would be his price for propping up Labour.
This is the important shift for investors. As Farage says, “The pressure on Ed Miliband to pledge a referendum is enormous”. For those who haven’t been following Labour’s election strategy, they have been working on the belief that 35% of the vote will deliver them a majority government, because of their natural advantage within the electoral system. After his universally acknowledged dreadful party conference speech, given without notes and where he ‘forgot’ to mention the deficit, his own party are turning on him.
So getting back to those initial conclusions:
1) UKIP’s potential number of MPs is highly uncertain, but given the risk of a coalition government it’s not beyond the realms of possibility that they might hold the balance of power, in a confidence-and-supply arrangement. That’s not a formal coalition but one where UKIP would vote through a minority Government’s budget while retaining independence and taking no ministerial posts
2) The Conservatives will now come under pressure from their eurosceptic wing to be more aggressive on the EU referendum
3) And Labour will be under pressure to even deliver a referendum
While UKIP retain their momentum, the risks for a referendum are rising. EUR/GBP vol now looks to be a decent buy again, after its pullback post Scotland referendum. This issue is not going away and political risk for UK assets is rising.