IN A FORTNIGHT Britons vote in their country’s third general election in less than five years. Economists are as polarised as voters as to what a Conservative or Labour government means for Britain’s prospects. Economic models vary on the impact of Labour’s statism and the Tories’ intention to “get Brexit done”. Financial-market participants have little choice but to take a view. And their collective opinion can be inferred from markets’ responses to changes in the perceived likelihood that Boris Johnson or Jeremy Corbyn will be prime minister on December 13th.
The value of the pound broadly reflects their assessment of British assets. And since the election was called on October 31st it has varied with changes in the prospects of Mr Corbyn or Mr Johnson securing office. Those prospects can be deduced from betting odds, which can be turned into estimates of the probability that either man will win. Strikingly, a simple linear regression suggests that changes in these probabilities explain 40-50% of the variation in the Bank of England’s broad trade-weighted sterling index over the last few weeks.
Our calculations suggest that an increase of ten percentage points in the probability of a Conservative majority lifts sterling by 0.5%. A similar rise in the prospects of a Labour government (including a minority administration) lowers it by 1% (see charts). Recently betting markets have suggested a 65% probability of Mr Johnson having a majority and just 22% of Mr Corbyn entering Downing Street. (Other possible outcomes include another Tory minority administration.) That, in turn, suggests that the pound will rise by 1.75% if Mr Johnson wins outright and fall by 7% if Mr Corbyn replaces him.
It seems that markets now worry about Mr Corbyn more than they do about a no-deal Brexit, which used to terrify them. If Mr Johnson secures a majority, Parliament is likely to pass the Withdrawal Agreement he secured with the European Union in October. Although this is a fairly “hard” form of Brexit, it should lessen the potential for an acrimonious and chaotic “cliff-edge” break, at least until the end of the year, when the transition period is set to expire.
Betting markets can get forecasts badly wrong: they predicted an easy win for Remain in the Brexit referendum in 2016. But they are roughly consistent with derivatives markets, with sterling option contracts implying that the probability-weighted expected movement on election day is around 2.5%: 65% chance of a move 2% up, 22% chance of a 7% drop.
After a poll by YouGov published on November 27th, the largest of the campaign so far, suggested that Mr Johnson will win a healthy majority, the probability of a Tory majority on the betting markets went up to 70%. Consistent with The Economist’s simple model, sterling rose by 0.25%. If the pollsters and the markets turn out to be wrong, the pound has a long way to fall.