LONDON BRIEFING:Markets hate uncertainty and that's just what the Tories' dwindling lead in the polls has given rise to, writes FIONA WALSH

THE ELECTION battleground switched from Westminster to the foreign exchanges this week, with sterling the main casualty.

Behind the plummeting pound was a Sunday Times poll which showed that the Conservative lead over Labour had shrunk to just two percentage points, raising the prospect of a hung parliament – the first in Britain for 36 years.

There’s nothing the markets fear more than uncertainty and the poll results sparked a wave of speculative selling on the foreign exchanges. Sterling dropped more than four cents against the dollar at one point, tumbling through the $1.50 level to hit a nine-month low, and also weakened against the euro, raising the spectre of parity once again.

Politicians piled on the pressure as the Tories attempted to deflect their own dismal showing in the polls by issuing dire warnings about what’s in store if Labour should, by some chance, be returned to power.

Former chancellor Ken Clarke, now shadow business secretary in the Cameron administration, said the battering received by sterling over the past two days provided a grim demonstration of just how nervous Britain’s foreign creditors and investors have become. Victory for Labour would, he said, weaken the pound further and push the cost of borrowing higher.

“If investors don’t believe that a newly elected government has the political will to deal with the deficit and pay down debt, they will demand much higher interest rates,” he said.

While Gordon Brown has pledged to halve Britain’s record peacetime deficit of £180 billion (equivalent to 12 per cent of GDP) over the next four years, he has made it clear he will delay any swingeing spending cuts for fear of plunging the country back into recession. David Cameron, on the other hand, yesterday reiterated his pledge to call an emergency budget within 50 days of an election victory and plans far deeper, swifter spending cuts to tackle what he called the “dark black cloud” of the budget deficit.

Central to his plans to restore the nation’s finances is protecting Britain’s vulnerable triple-A credit rating, any downgrading of which would cost the country dearly.

If the election results in a hung parliament, the fear is that it will be virtually impossible for any meaningful measures to be passed, delaying any action on the mounting deficit until a new election can be held. By then, it may be too late for Britain’s battered economy.

Of course, it’s not unknown for politicians to work together in a coalition government, particularly in times of crisis, but it’s the prospect of political deadlock that has so spooked the markets.

This week’s mini-rout for the pound is just a taste of what will be in store if voters fail to reach a decisive verdict when they finally go to the polls. With sterling staring over the edge of the abyss, the markets don’t much care at this stage which party emerges as the winner, just so long as they secure enough of a majority to get on and govern.

AS Aformer cabinet minister in the Ivory Coast government, Prudential chief executive Tidjane Thiam is familiar with the rough and tumble of the political world. The next few months will be every bit as nail-biting for the man from the Pru as it will be for Gordon Brown, as Britain's biggest insurer gears up to raise £14 billion from its investors.

Proceeds of the record-breaking cash call will be used to help finance the Pru’s ambitious £23 billion purchase of the Asian operations of battered US insurer AIG. The deal, which Thiam hails as “transformational” is a huge move for the Pru, one of the oldest and best-known names in British financial services, and will more than double the size of the company.

Asia has exciting prospects as a growth market in financial services and Thiam is well respected in the City of London. But there are concerns over the scale of the move as well as the price being paid; concerns which have seen Pru shares crumble by 20 per cent in the past two days, from just over 600p to 487.5p.

The Pru will not set the price of its new shares until May and is clearly hoping to claw back much of this week’s losses in the intervening period. If the share price continues to fall, it will be forced to issue far more paper, which could threaten the mathematics of the deal.

There’s no doubt the insurer will get its money, however. The record-breaking rights issue is being underwritten by Credit Suisse, HSBC and JP Morgan Chase’s Cazenove, who stand to earn fees of $735 million for their services.

Fiona Walsh writes for the Guardian newspaper in London