By Peter Apps, Political Risk Correspondent
LONDON, May 7 (Reuters) - Britain's general election has produced the first hung parliament in a generation, with no one party in overall control and markets already becoming restive over the possibility political paralysis.
Below are the key risks to watch in the coming days and months.
GETTING A NEW GOVERNMENT
Opposition leader David Cameron's Conservative party have become the largest party in parliament but lack the outright majority that would have seen him invited to meet the queen, form a government and move into Downing Street on Friday.
Labour Prime Minister Gordon Brown remains in office with constitutionally the first chance to form a government. Third party the Liberal Democrats performed worse than expected but now effectively hold much of the balance of power.
Their leader Nick Clegg said on Friday that as the party with the most votes and seats, the Conservatives should have the first chance to form a government -- but that does not necessarily mean he would support them.
Mathematically speaking, the Conservatives would need the support of the Ulster Unionists and possibly other small parties to win a working majority, or could carry on as a minority effectively daring the others to force a no-confidence vote and bring down the government. To be truly safe, they would need at least the tacit support of the Liberal Democrats to hold off a no-confidence vote and support the budget.
Labour and the Liberal Democrats could form a coalition together, but they would still need other smaller parties to control more than half of parliament. But keeping the Conservatives out altogether after they won most votes might prove politically difficult.
Some analysts say the best scenario for markets would be a pact between the Lib Dems and Conservatives -- but that might prove a hard sell to the Lib Dem party itself and some worry it would be destabilised by differences on Europe, defence and tax.
What to watch:
-- How fast does clarity emerge on a new government? Sterling and gilts have already fallen sharply on the election result and if no government is in place by Monday, Britain could face a sharp sell-off in national assets. Ultimately, the financial markets -- already made restive by Greece -- could dictate the timescale of negotiations.
-- What does Prime Minister Brown do? Clegg has said he would not keep Brown in office if he lost the popular vote, leaving open the option of doing a deal with another Labour leader. Does Brown resign, or is there an internal coup against him? Other Labour kingpins such as business secretary Peter Mandelson will be key, with potential contenders for the leadership including Foreign Secretary David Milliband and Home Secretary Alan Johnson. If Brown steps down, Queen Elizabeth could invite whoever she was advised most likely to form a government to become prime minister, most likely Cameron.
-- Noises from the three main parties. Sterling rallied after Clegg said the Conservatives should have the first chance to form a government. A Lib Dem meeting on Saturday could be key to their actions. Markets would prefer conciliatory statements suggesting possible compromises between the parties, and may react badly to a worsening tone.
WHEN GOVERNMENT IS FORMED
Forming a government is only the beginning. Credit ratings agencies and investors have warned Britain needs to begin to address its record deficit, forecast this year at 11.1 percent of gross domestic product.
The Conservatives have promised an emergency budget, and analysts say any coalition government will likely do the same. The greater question is whether the budget can get through parliament and whether it will mollify markets and ratings agencies.
Whoever ends up as prime minister, they will need the support of smaller parties almost continuously. Any strains in those relationships could unsettle markets and even prompt new elections.
What to watch:
-- the queen's speech outlining policy priorities and budget -- and the market and ratings agencies' reaction to them -- will be key. Ratings agencies say all three parties have proposals that would begin to address the deficit. The question is whether a fragile government would be prepared to push through tough measures. The Lib Dems want a more redistributive tax system and could baulk at supporting a Conservative budget built around public spending cuts with no tax rises. At the same time, the electorate might punish any smaller party which was seen to have scuppered the budget and prompted a new financial crash.
-- Who emerges as finance minister could also be key to market credibility. A Reuters poll of financial institutions showed them viewing Conservative business spokesman and former Chancellor Ken Clarke as their favoured option. Actual conservative finance spokesman George Osborne lagged in fourth place behind Labour Chancellor Alistair Darling and Lib Dem finance spokesman Vince Cable..
-- Two opposition parties step back into the background, or do they begin pushing for a no-confidence vote to spark a new election. Analysts say this is unlikely, as any new election might result in a larger Conservative victory and punish smaller parties.
FURTHER RISKS AHEAD
Markets want to see a strong, stable government but analysts warn that whatever government emerges from this election will probably be neither.
Any minority government will have to work continuously to keep on board both its allies and own backbench MPs. The need to get every single MP into the House of Commons chamber to push through crucial votes can itself make policy making difficult. Ministers may have to be recalled from overseas visits at short notice, for example.
Reigning in the deficit will mean difficult public spending cuts, which at worst could prompt labour and possibly civil unrest and would be difficult even for a majority government. Some analysts warn whoever ends up in power now could easily lose the next election.
what to watch:
-- Another election if the incoming government loses a vote of confidence. Bookmakers see a one in three chance of a new election this year.
-- Is a move towards electoral reform the cost of the support of smaller parties? This would change Britain's political system forever, likely ushering in many more coalition governments, an end to the two-party system and different policy-making dynamics.
-- While rating agencies say at present the election result poses no direct threat to Britain's AAA status, they will continue to watch closely. Greece, Spain and Portugal have all recently seen downgrades prompting immediate market routs
-- Do public spending cuts prompt industrial or even social unrest, or push the economy back into recession? Either could worry markets and hit enthusiasm for further tightening.