Like a toddler on a long drive, the UK bond markets are hot, grumpy and ready to puke. Gilt yields – the borrowing costs imposed by these markets – have reached feverish, multi-decade highs as ministers resign and MPs call on Keir Starmer to step down. Starmer’s supporters argue that this is precisely why you can’t get rid of him: he and his Chancellor, Rachel Reeves, have the backing of the market. BBC News is reporting that the investors who trade UK government debt are “unsettled” by the “perceived risk of looser public spending” that would result from a new, more left-wing Prime Minister.
This isn’t true. It serves an argument Starmer and Reeves have made repeatedly: depose us, and you’re in Liz Truss territory. But it’s a supposition, a crass generalisation of what thousands and thousands of people in different countries (and a whole bunch of algorithms) might think. It is at least as credible to argue that as far as the market is concerned, Starmer is the problem.
The reasons for this is that investors in UK government bonds (and all other bonds) care about two things: inflation (which reduces the future value of their investment) and public spending (which means more bonds are sold, and therefore demand is reduced). A new Prime Minister might spend and borrow more, they might have policies that could be inflationary, but investors don’t know this, because the people most likely to succeed Starmer haven’t laid out their proposed fiscal plans yet.
What they do know, however, is that Keir Starmer has attempted fiscal consolidation, and failed. There are two ways to perform the consolidation that markets take as a reason to pay more for bonds: reduce spending, and raise tax. Starmer could not persuade his backbenchers to accept the unpopularity of removing the Winter Fuel Payment, a tiny bonus for the nation’s pensioners, almost half of which had already been eaten by inflation without anyone noticing. He certainly couldn’t persuade them to accept cuts to disability benefits. No significant reform of the tax system has been attempted, only a handful of nibbling changes.
The fact that he is incapable of pushing through fiscal consolidation measures with 403 MPs arguably makes this worse: the political problem that has been priced into the high yields on UK gilts is not chaos, it is incapability. The market does not care if you are a sensible and decent man. At a time of very high government debt and low economic growth, the market despises incremental change almost as much as the public.
That’s not to say that the bond market isn’t affected by the challenge to Starmer’s leadership. Clearly, the rises in gilt yields (which means investors are selling off UK government debt) are timed with developments in the Starmer drama and the uncertainty it represents. This uncertainty premium only represents a small component of the overall rise in yields over recent weeks, however. Andrew Goodwin, chief UK economist at Oxford Economics, says the “vast majority” of the increase in gilt yields since the beginning of the Iran war is related to the inflation that investors expect to be caused by the conflict, to which political uncertainty has added “a small premium”. It is worth noting that there is no shortage of demand for UK gilts: the government sold £4bn of newly issued gilts into the market this morning, for which investors made £13.4bn in bids.
Goodwin agreed that the Starmer-Reeves approach of trying to raise taxes without being unpopular – by increasing smaller taxes more sharply – “undermines the credibility of the consolidation”, because such changes create more of an incentive for people to change their behaviour to avoid the tax. Similarly, he said a fiscal framework that puts many changes in later years – perhaps in the hands of another government – was not convincing to investors. But mainly it’s a perception among investors “that the UK is more vulnerable to some energy shocks than elsewhere” which imposes higher yields: Britain’s long, long battle with inflation matters more than today’s political drama.
Certainly there are new ideas among Starmer’s challengers that are unlikely to settle a fractious market. This morning, a group of soft-left Labour MPs published their plan for a new fiscal framework that would put spending cuts even further into the distance – which one City strategist called “as tone-deaf to the current global and local bond market jitters as Liz Truss was”. There are doubtless better ways to measure the effects of investment, but to suggest changing the rules now, with yields at multi-decade highs, is unlikely to be welcomed by a sceptical market.
Nevertheless, bond yields have been elevated for a long time, and the overall picture remains the same: investors see Britain as an inflation-prone country that has failed to fix its spending problems and its dysfunctional tax system. It is not the challenge that is the problem; it is the status quo.
[Further reading: Keir Starmer will be remembered as a pub quiz question]
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