The pound has hit its highest level since late February after the Conservatives emerged as the winner from the general election.
Sterling surged by 1.75% to $1.55, its highest level since late February, after an exit poll predicted that the Tories would be the largest party.
But by 6am a revised exit poll said David Cameron was on course to win 325 seats and Labour on 232, giving the Tory leader an overall majority.
This much better than expected election performance by the Tories sent FTSE futures higher with traders hoping that an end to coalition government would confirm the extension of the Conservatives’ austerity programme and reduction of the national debt.
Traders predicted the FTSE 100 would be 70 points higher when the markets open at 8am. The index of Britain’s 100 biggest companies closed down 47 points at 6,887 on Thursday, before the exit poll was published.
The pound rose strongly after the exit poll at 10pm, and continued to rally as results came in from across the country. By 5.30am it had gained almost three cents against the US dollar.
Sterling also gained strongly against the euro to pass the €1.38 mark by 5am.
Alan Clarke, a fixed income strategist at Scotiabank, said: “Against the odds, on the basis of the exit poll seat projections, a second Conservative-Liberal Democrat coalition looks a distinct possibility.
“This is most likely to come as a pleasant surprise to financial markets. Our judgment is that the markets were bracing for a messier outcome where the Labour party would be reluctantly propped up by the SNP.”
However, Clarke said the market’s biggest concern will be “the prospect of an EU referendum as promised by David Cameron if he was still prime minister”.
Chris Beauchamp, a senior market analyst at IG, said the Tory surge had electrified markets. He said: “The exit poll certainly comes as a surprise, putting the Conservatives well ahead on 316. Crucially, Cameron is expected to still be short of a majority, but it looks like any putative anti-Tory coalition will have a harder job on its hands blocking any Queen’s speech authored largely by the Conservatives.
“A strong Conservative element to the next government sends the message that the economic policies of the past five years will continue, removing concerns about an early end to austerity.”
However, he warned that the pound could fall back as it dawns on traders that the Conservative party has promised to hold a referendum on Britain’s membership of the EU. He said: “We could see the pound drop back as this realisation sinks in.”
Jeremy Cook, the chief economist at World First, said: “Markets were sat waiting for this poll, looking for either of the main two parties to get close to 300 seats and make the building of a coalition that much easier: 316 is a lot better than anyone was expecting and sterling is benefiting widely from this.
“Obviously we can talk about the risks of a referendum on EU membership but, should this poll hold, the risk of a drawn-out, squabbling and disorganised coalition-building period seems to have been put to bed and sterling is back in favour.”
Before the poll was released, the pound had ended the day roughly flat at $1.52.
Daragh Maher, a currency strategist at HSBC, said: “Sterling is rallying in a historically appropriate way to signal that Cameron is most likely to be the next prime minister. Going into the exit poll, the market was anticipating a messy signal and would be anticipating some sterling weakness.
“An outcome in line with the exit poll would in the short term be business-friendly, given that it would not lead to weeks and weeks of wrangling, but the medium-term story really begins to put the spotlight onto an EU referendum.”
While the City’s reflex approach may be to favour the Conservatives, with the party’s plans for more rapid deficit reduction, over Labour, which has promised to take on vested interests, including in the financial and energy sectors, analysts said investors were very concerned about the risk of Britain leaving the EU under a Tory-led coalition. Cameron has promised a referendum on whether Britain should leave the EU by 2017.
Brian Hilliard, the chief UK economist at Société Générale, said: “If I’m layering the risks, and seeing what is the thing that could do most damage to markets after the initial stage, then it’s Brexit, rather than the fiscal plans of the Labour party.”
He added that with Europe’s bond markets in a tailspin on Thursday, it was hard to separate pre-election nerves from other factors weighing on markets. He said: “I don’t think you can isolate the effects of the election.”
German bond yields – the interest rate that Berlin pays on its borrowing – shot up before collapsing back later in the day. Jasper Lawler, from CMC Markets UK, said: “European stock markets were left a little out of breath on Thursday as government bond markets pulled a full 180-degree turn from savage losses to a sizeable move higher.”
According to BATS Global Markets, it was one of the busiest days for European stock markets in the past two years. About €72bn (£53bn) of shares changed hands – double the average for a typical day in May.
