Leading City economists warn of mayhem in the markets unless David Cameron and Nick Clegg agree a deal to form a new government before the markets open tomorrow morning.
Peter Spencer, chief economist at the Ernst & Young Item Club, said yesterday: "There will be a meltdown in the markets unless Cameron and Clegg come up with a plan. If they do agree, and give a commitment to go ahead with the planned emergency budget – timed for June or July – to cut the deficit, then investors will become confident again."
But Mr Spencer warned that if they fail there could be another general election within months, as the alternative – some sort of progressive alliance on the left – will be shot down by the markets. "Investors won't like a Cameron-led minority government either; they want him and Clegg to stake their reputation with a clear mandate."
Jitters over the knife-edge election result have already unsettled the UK markets with the pound down four and a half cents against the dollar on Friday, while the FTSE 100 index of leading shares fell 2.6 per cent, its worst week for 14 months. Bank shares were hit hardest on fears over their big loans to troubled eurozone countries but also because of worries that Tories and Lib Dems have warned they may break up the banks. But the prices of UK gilts held up as credit-rating agencies said the inconclusive poll result was not yet a threat to Britain's triple-A rating.
Adding to investor nerves in the UK is the outcome of today's meeting in Brussels between Europe's 27 finance ministers to approve emergency powers to stabilise markets that have been in freefall over the Greek debt crisis. EU leaders hope to create a package of measures – the European Stabilisation Mechanism – to shore up the euro and underpin fragile sovereign-debt markets.
Today's crisis meeting was called following the emergency summit held on Friday night to finally back the EU-International Monetary Fund $140bn bailout for Greece. EU leaders had hoped the deal might douse the flames, but the volatility in the markets on Friday turned the summit into a furious exercise in global crisis management and damage-limitation.
One of the main criticisms from investors over Greece has been the failure of EU leaders to respond quickly enough to quell fears that the debt crisis may spread, and to spell out how they plan to cut deficits, specifically in Portugal and Spain. One market investor said: "Both countries have huge deficits and they are not over their EU limits. But because no one has said anything about how they are handling them, the markets have over-reacted, anticipating the worst. There's the same fear about the UK if we don't get quick action from a new government."
President Obama's intervention late last week added a new urgency following his warning that failure to halt the euro's collapse was infecting the rest of the world. In New York the Dow Jones recovered on Friday from one of its biggest falls for years, but Asian markets were also sharply lower over fears that the eurozone problems were not being dealt with quickly enough following big rises in the cost of borrowing across the zone. Investors are also nervous about the exposure of Europe's banks to the more troubled countries, stoking fears of a secondary banking crisis.
But Nicolas Sarkozy, the French President, and the German Chancellor, Angela Merkel, raised the stakes with a pledge to defend the euro at all costs. Ms Merkel, who is under huge pressure from taxpayers over the cost of the Greek rescue and is facing an important local election today, said she wants the EU to speed up reforms to regulate the markets.
EU ministers will also thrash out today details on plans to tighten EU budget rules and bring in more sanctions for breaking debt guidelines and to control deficits, which is what investors want to hear most.
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