Keir Starmer’s resignation as British prime minister on Monday had felt inevitable for a while, and now the coronation of Andy Burnham as the next leader of the Labour Party and prime minister looks likely to be wrapped up by mid-July.
Financial markets had long since priced in a Starmer departure and Burnham’s recent comments about sticking to the current fiscal rules, along with Wes Streeting’s backing of Burnham, which removed the risk of a lengthy leadership contest, means gilt yields were little changed on Monday.
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Assuming Burnham is coronated, the next key moment to watch will be his choice of chancellor. Appointing Ed Miliband may suggest a willingness to spend or borrow more, while someone like Streeting would be more market friendly.
Indeed, Burnham has recently committed to sticking to the current fiscal rules but has also suggested that he wants to spend more to support households.
That said, the challenge of balancing the trilemma of increasing spending pressures, already high taxation and manifesto commitments, all while trying to please the bond market will constrain whoever the top team in Downing Street turns out to be.
As a result, there are two broad options for fiscal policy.
- Stick with the current framework: The first is to stick to the current fiscal framework, opting to raise taxes and spending broadly equally, which would result in little change in borrowing. This would keep bond markets happy but would likely mean Burnham would be unable to enact the reforms he would want while sticking to the manifesto commitment to not raise the three major taxes. This raises the risk of more complex, distortionary taxes, which are difficult to implement and often raise less than advertised once behavioral effects are accounted for.
- Loosen the fiscal reins: The second is to loosen policy and borrow more, either by changing the fiscal rules or by borrowing more now and pencilling in bigger cuts later on. But it will be difficult to sell more backloading of taxes to markets, given that current fiscal plans are already heavily backloaded. Gilt markets are already highly sensitive to any signs of more borrowing. What’s more, more spending now would risk stoking inflation and could prompt the Bank of England to raise interest rates.
The most likely result is a bit of both. That means more taxes and borrowing, and probably higher gilt yields over the next couple of years.
But we don’t rule out a Burnham government doing something more dramatic. After all, Labour is wallowing in third in the polls and will only have two years or so to change that.
Given that big investment projects, like building more social housing, take years to bear fruit, he may feel he has to do something big and quickly to have a chance at winning the next election.
Ultimately, though, any big plans will have to pass the bond market test. We doubt Burnham will make changes to the fiscal rules for fear of spooking the bond markets, which he has spent the last couple of months trying to reassure in the hopes of avoiding another “Liz Truss moment.”
That means the most likely outcome is another round of tax and spend with a little more borrowing later this year. That will represent little change to the fiscal plans that we saw the previous government make and will do nothing to boost the UK’s long-term economic growth rate.
