The bond market's specter of doom looms large over Britain's political landscape, with the potential for another Liz Truss-style crisis looming. As the UK faces rising borrowing costs and warnings of a 'Liz Truss moment', the question of whether Keir Starmer's leadership is at risk has sparked a sharp sell-off in the market for UK government debt. With the prospect of a sixth prime minister in seven years, the country's political instability has investors worried about a return to higher levels of borrowing and a left-wing shift by Labour.
Nigel Green, CEO of deVere Group, warns that markets hate uncertainty, especially a political vacuum. He emphasizes that a cabinet resignation followed by a leadership fight would signal government control loss, with investors already questioning the country's fiscal direction. Green highlights that markets can handle ideology if it's disciplined and coherent, but they recoil from higher borrowing without a credible growth engine.
Within Labour ranks, some MPs are defiant, frustrated by Starmer's tight approach to tax and spending despite plunging poll ratings. Paula Barker, a Merseyside MP and ally of Andy Burnham, suggests financial markets will 'have to fall into line' if Burnham becomes PM. Diane Abbott, a left-wing grandee, even suggests MPs 'might as well go home' if bond market considerations trump other priorities.
However, investors warn that ignoring the fragile public finances and realpolitik of the markets could be fatal for any prime ministerial candidate. Reto Cueni, chief economist at Syz Group, highlights the risk of another Liz Truss moment if political leadership changes or current leaders opt for more fiscal loosening. The backdrop is precarious, with government borrowing costs rising worldwide due to the Iran war's economic damage.
Britain's elevated borrowing and debt levels add to the concerns. With years of lacklustre growth and rising pressure to repair public services and support an ageing population, the UK's national debt stands at almost 100% of GDP, the highest since the 1960s. Rising interest rates worldwide due to post-pandemic inflation and the Russian invasion of Ukraine further increase the cost of servicing debts.
Analysts at Goldman Sachs note that any new leader would face the same challenges, with policy choices constrained by rising spending pressures and an elevated tax burden. Mark Dowding, chief investment officer at RBC BlueBay, warns of a vicious spiral where the fear of higher borrowing costs drives costs even higher, potentially reaching an unsustainable tipping point.
Despite the risks, most City investors expect a balance between shifting direction and keeping the bond market onside. Louise Haigh, a powerful Labour MP, proposes higher borrowing by overhauling the chancellor's fiscal rules. However, she emphasizes the need to wait until after Labour meets the target of balancing day-to-day spending with tax receipts.
Some analysts predict Labour will seek a balance between a 'fresh start' and avoiding a Truss-style provocation, potentially keeping the chancellor, Rachel Reeves, to benefit from her reputation with City investors. Jordan Rochester, an analyst at Mizuho, suspects the new leadership will attempt to calm markets with words, but the party's leftward shift will be priced in first. In my opinion, this scenario highlights the delicate balance between political ambition and economic stability, with the bond market acting as a critical arbiter of Britain's future.
