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As Britain's election looms, stock-market wobbles appear

By Lionel Laurent and Alistair Smout

LONDON, April 28 (Reuters) - With Britain's most unpredictable general election in decades just over a week away, investors and traders are bracing for wobbles on a stock market that up until now has soundly shrugged off political risk.

Britons head to the polls on May 7, and barometers of stock market volatility are beginning to rise while domestically exposed stocks underperform as polling data and campaign developments build up twitchiness on dealing desks.

Investors tend to favour Prime Minister David Cameron's Conservatives over the left-of-centre Labour Party, which has vowed to regulate utilities and hike taxes on banker bonuses.

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However, U.S. banks such as Goldman Sachs (NYSE: GS-PB - news) and Citi have warned of economic uncertainty should the Conservatives win because of their promise to hold a referendum over Britain's membership of the European Union.

Late-race policy announcements such as Labour's promise of rent controls have already this week hit specific sectors such as housebuilders and property firms like Zoopla, with risk gradually spreading beyond sectors like utilities.

The Scottish National Party, the euro-sceptic United Kingdom Independence Party and the Liberal Democrats, who have partnered the Conservatives in government, all hope to wield influence following a vote where no party is likely to command a majority.

Few expect a widespread election-driven hit to Britain's blue-chip FTSE 100 index, which touched an all-time high on Monday as years of post-crisis easy money from central banks continues to trump politics. The index's components are relatively globalised and a major poll upset is unlikely.

But election ripples are breaking the surface, and memories of last year's Scottish independence referendum, which only ruffled markets just before the vote, are frequently invoked.

"It's a little bit like with the Scottish referendum, the closer you get to the finishing line, you do tend to get a few wobbles," said Chris White, head of UK equities at Premier (NasdaqGS: PINC - news) .

"I think there will be more... (The election) is at the forefront of investors' minds now."

INCREASED HEDGING

Premier's White said he would not be making further changes to his portfolio, having already cut exposure to domestic utilities and the gambling sector among others.

A Reuters basket of domestically exposed stocks including Lloyds and Tesco (Xetra: 852647 - news) , which had outperformed international peers since mid-February, is now lagging the FTSE 100 year-to-date with a 7.7 percent rise compared to an 8.2 percent rise for the broader stock-market index.

Some of the moves are linked swings in foreign exchange markets. A new poll that showed Cameron building a six-point lead over Labour sent sterling to a seven-week high on Monday, pinning back the pound-denominated FTSE 100 in the process.

However, traditional measures of stock-market volatility appear to point to a slightly increased level of investor jumpiness too. The VFTSE is up 50 percent since mid-March, while the U.S. VIX index is down 3 percent and the European VSTOXX is up 20 percent.

"In advance of major changes, you'll get people wanting to increase their hedging activity around that, in case there's a bad outcome," Jeremy Lawson, chief economist at Standard Life (LSE: SL.L - news) Investments, said. "In practice, unless you can't form a stable government, then some of that fear will naturally dissipate."

On a more long-term basis, investment banks and fund managers appear broadly sanguine about equity market risk.

"We suspect that risks for the UK economy and financial markets emanating from a minority government are far less than in the 1970s and indeed are rather modest," Citi strategists wrote in a note, adding there was increasingly "limited daylight" between the country's two main parties.

Despite the uncertainty in the polls, the lessons from the last election mean that concerns over governmental stability could be overdone.

"Back in 2010, a lot of people thought the Liberal Democrat/Conservative coalition also wouldn't last. There were lots of concerns around that, but it actually proved to be enduring," Standard Life Investments' Lawson said.

"That's the key test." (Editing by Crispian Balmer)