LONDON — Just as its Conservative predecessors did before it, Britain’s Labour government risks driving the U.K.’s economy into a ditch with an internal party fight over the steering wheel.
The pound has had its worst run against the dollar in 18 months, the stock market has slumped and the government’s borrowing costs have hit multi-year highs this week as Labour’s top brass turned on one another in response to a disastrous showing at nationwide elections last week.
Unless it can restore order quickly, that’s going to translate into higher interest rates for businesses, higher credit card bills and mortgages, as well as a fresh cost-of-living squeeze as the prices for essential imports such as food and energy grind higher. That’s exactly the outcome Prime Minister Keir Starmer promised to avert when he won a landslide last year.
The timing of the latest episode of British political dysfunction is — to put it mildly — inopportune. With no end to the U.S.-Israeli war with Iran in sight, global prices for oil, gas and several other key inputs for the economy are rising worldwide. Until March, markets had hoped for the Bank of England to cut interest rates twice this year. Today, they expect it to raise them at least twice in order to keep a lid on inflation.
The willingness of global investors to take a punt on the U.K. is fading as a result. Marc Ostwald, a strategist with the brokerage company ADM ISI, told clients on Friday that markets expect whoever emerges as leader from the current scuffle to end up running a bigger deficit, and are consequently attaching bigger risk premiums to all U.K. assets. This, he said, is driven “in no small part” by memories of Liz Truss’s ill-fated Tory premiership.
The kindness of strangers
The U.K. is by no means alone in its woes, but as a country that — in the words of Canada’s Mark Carney (formerly Britain’s central banker) — depends on the kindness of strangers to fund big budget and current account deficits, it finds itself in a particularly difficult place right now.
One phrase that has haunted markets all week has been a comment made last year by Greater Manchester Mayor Andy Burnham — seen as the most likely challenger and successor to Starmer — that the country must “get beyond this thing of being in hock to the bond markets.”
At the time, the comment was taken as fishing for support among more left-wing Labour MPs frustrated by Chancellor Rachel Reeves’s refusal to borrow more heavily, and as a signal of intent to throw off her shackles if ever Burnham got the chance. He tried to row back those comments at the start of the year, saying he was only complaining about previous governments, which had brought the U.K. to its current state.
But some of his allies are sticking to the original, more radical interpretation. Paula Barker, the MP for Liverpool Wavertree, told Times Radio earlier this week that markets would “just have to fall into line.”
Ultimately, it’s the government that needs to find nearly £2 billion a week to plug the gap between what it spends and what it takes in taxes. Global investors, who currently hold around one-third of all U.K. government debt, are under no obligation to keep lending to it.
Moreover, said Fathom Consulting managing director Erik Britton, even Burnham’s row-back is problematic.
“The U.K. is in hock to bond markets because it has borrowed from them,” Britton said on LinkedIn. “Asserting that we should not be ‘in hock’ is like asserting that you are intending to default. That’s just not a smart move for a potential PM.”
Irrespective of the outcome of any leadership bid, investors appear dismayed by the latest iteration of a U.K. political pathology characterized by panicked and simplistic responses in the face of complex and hard-to-change economic realities: population aging, inequality, geopolitical fragmentation and environmental degradation.
“Any new prime minister would be subject to the same constraints that the current government is facing,” Bill Papadakis, chief investment officer with private bank Lombard Odier, wrote in a note to clients.
Papadakis noted that for all the drama of the last two years, Starmer’s government has succeeded in narrowing both the budget deficit and the current account deficit, and he argued that “a radical change in fiscal stance is neither immediate nor particularly likely.”
Ostwald, too, thinks that markets may be making too much of the current upheaval, pointing to figures released earlier this week that showed the economy grew 0.6 percent in the first quarter — the fastest of any G7 economy. Even if that exaggerated the economy’s actual strength, he said, “there is a great deal more resilience in the economy than the media narrative conveys.”
However, both acknowledged that even the best outcome will require months of drift until the leadership issue is settled at Labour’s annual conference in September, leaving the pound, gilts, and the FTSE all at the mercy of not just a party civil war, but trade and shooting wars too.
