UK Election 2015

UK elections: Is anyone able to form a government?

Peter Macdiarmid | Getty Images

The 2015 United Kingdom general election is shaping up to be the closest and potentially the biggest headache for markets for decades. The reason? Thanks to the increasing influence of smaller parties, this vote could spell the end of the traditional two-party system that has dominated U.K. politics since World War II.

Since 1945, Brits have only really had one choice when it comes to government: either left-leaning Labour or the more right-wing Conservatives, currently leading a coalition with the smaller Liberal Democrats. But now the likes of the Scottish National Party (SNP) and the U.K. Independence Party (UKIP) could hold the key to who forms the next government.

With both Labour and the Conservatives hovering between 30-35 percent of the vote in a range of polls, it seems unlikely at this point that either will be able to govern alone.

Trade in sterling has already become more volatile than before any election since 2000, as worries about post-election risk intensify.

CNBC takes a look at why every vote counts in the May 7 U.K. general election and which party, or group of parties, could form next government.

Share of the vote… wins?

Owing to the vagaries of the U.K.'s first-past-the-post constituency system, Labour could become the largest party with a smaller share of the vote than the Conservatives.

Labour support is stronger in the north of England and Wales, where constituencies in general have fewer people, whereas the Conservative power base in London and the South, where constituencies on average have a larger population. This means that the Conservatives have to fight harder and are likely to win fewer seats even with the same share of the vote as Labour.

Prime Minister David Cameron failed in his attempts to tackle this issue while in power – while he tried, but failed, to pass legislation reducing the number of constituencies from 650 to 600 after he was blocked by coalition partner the Liberal Democrats.

Labour pains?

Labour has simply got more options to form a coalition. The Liberal Democrats have been burned badly from five years of coalition with the Conservatives, and so seem less likely to do it all again. Labour could also form a coalition with the Green Party, Welsh Nationalists Plaid Cymru, or – what looks more likely – a coalition or "confidence and supply" agreement with the Scottish National Party.

This would involve SNP support for Labour in the event of certain key votes, such as no-confidence or spending votes, but could come at the cost of granting concessions to the more left-wing SNP.

United Kingdom Independence Party leader Nigel Farage
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There has been no confirmation of a formal coalition agreement between any major party - although the SNP formally offered to make an "anti-austerity" government with Labour this weekend, the larger party has so far preferred to try and win enough votes to govern alone.

"Whatever you think about left/right politics, the worst possible result for Britain is likely to be a weak Labour performance," Bill Blain, strategist at Mint Partners, argued.

"It may be time to think the unthinkable.. a strong Labour result will be better for Britain than a weak Labour performance causing them to form a coalition with the SNP."

One plus point of a Labour-led government to investors would be the probable absence of a referendum on the U.K.'s EU membership. Despite some pressure, Miliband has not promised one, unlike Cameron.

Conservative Party and…?

The Conservatives have the weight of five years in power behind them, which could mean that they capture last minute risk-averse voters – especially when the pro-government U.K. newspapers like the Daily Telegraph run front page stories about 100 business leaders arguing against a Labour government.

Between now and polling day, the party is expected to continually reinforce its core messages: its relative economic competence and Labour leader Miliband's weaknesses.

Britain's Prime Minister David Cameron leaves 10 Downing Street in central London, March 18, 2015.
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One of the most optimistic predictions for them comes from Nomura's analyst team, who think that 290-295 seats (out of 650) for the Conservative Party, followed by a formal coalition with Northern Ireland's Democratic Unionist Party (DUP), with an expected 8 seats, and occasional support from the Liberal Democrats is "a realistic target".

"Although this would be a weak mandate for the Conservatives, its economic plans remain far removed from the alternatives," the Nomura analysts argued.

These would be rather odd bedfellows – Cameron's Conservative Party, which brought in gay marriage legislation, and the DUP, one of whose members is trying to introduce new legislation known as the "gay cake" law that will effectively allow discrimination if it is part of the business's religious belief. This has come out of a well-known case where a Northern Irish baker refused to take an order to make a cake saying "Support Gay Marriage" over an image of Sesame Street's Bert and Ernie – think of it as the U.K.'s equivalent of the row over the Indiana religious freedom law.

The DUP would also be likely to extract more promises on investment in Northern Ireland, where the economy is still not back on pre-credit crisis form.

The Farage factor

UKIP, led by Nigel Farage, were at one point mooted as a potential coalition partner, which would have heightened market fears that the U.K. could leave the European Union, but now seem more likely to disrupt the main parties' votes in swing seats than to actually win more than a handful of seats themselves.

- By CNBC's Catherine Boyle