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Sir Keir Starmer’s Cabinet has come together to publicly back him, and he seems to have faced down any immediate threat of a coup. But given the volatility in Westminster, it’s not unreasonable to ask: how would the markets react to Angela Rayner in Downing Street?
There’s an obvious one-word answer: “badly”.
We had a glimpse in the past few days of the fears that investors hold should a more left-wing leader replace Starmer. At the end of January, ahead of the latest round of revelations from the Epstein files, the pound was trading at $1.38. Then a week ago, as fears that Starmer would be pushed out mounted, it fell to $1.35. Now, as his position has been stabilised, it has recovered to $1.37.
Much the same happened on the Government bond markets. The yield on the benchmark 10-year gilts was close to 4.5 per cent at the beginning of the month. It pushed up to over 4.6 per cent in trading both on Thursday last week and on Monday ahead of Starmer’s crucial speech to Labour backbenchers. Now it has fallen back to 4.5 per cent.
These are little twitches. They reflect the fact that while the global investors that drive the markets are not particularly keen on the policies of the present Prime Minister and Chancellor, they fear something worse is around the corner. Already, the UK Government has to pay a higher rate of interest to fund the national debt compared to that of any other major economy. For most of the time under the previous Tory government we were paying less than the US, and that relationship held right through to the summer of 2024 when Labour took over.
Moods change, but right now it does very much look as though whoever replaces Starmer will have a tough time convincing investors that they can run the country’s finances in a sound way. So the premium we have to pay will continue, and the greater the gap between what is spent and what is raised in taxation, the greater that premium will be.
So what might this mean for a government led by Angela Rayner? At best, she is seen as inexperienced in matters of finance. At worst, she would seem not to care about what the markets think – though at least she hasn’t gone public on that, as Andy Burnham did last September when he said: “We’ve got to get beyond this thing of being in hock to the bond markets.” That bumped up the interest rate on gilts for a few days until the markets realised that he wasn’t the frontrunner to become PM after all.
The mainstream view, then, is that her government – or that of any left-wing leader – would face some sort of financial crisis. This would be akin to that which confronted Liz Truss, but because the fiscal position of the UK is regarded as weaker now than then, it would be on an even larger scale.
It’s a bleak outlook, but is it right?
There are two reasons why things might turn out better than expected. One is a general point. Successful governments have a prime minister and a chancellor that work together. One does the politics; the other does the money. They may not like each other. There may be tensions between them; indeed, there probably should be serious disagreements. Eventually those partnerships fall apart, as they did with Margaret Thatcher and Nigel Lawson, and Tony Blair and Gordon Brown. But while they last, they are effective.
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The problem at the moment is that the PM is not very good at the politics and the Chancellor not very good at the money. It is, however, plausible that Rayner could do the politics in the sense she could hold Labour backbenchers together. So everything would hinge on her finding a Chancellor who could make the sums add up. That would mean a combination of better discipline over spending and an increase in one of the big taxes, probably income tax.
The other reason for modest hope is that there may be a bit more growth in the next couple of years. This has little to do with the policies of this government, and all to do with the global economy, which despite everything seems to be picking up some pace. It seems to have brushed off the burden of Donald Trump’s tariffs, and is gradually getting inflation back under control. The UK economy is driven by the success of its service industries, with service exports far outpacing goods exports. These seem to be continuing to boom and are largely unaffected by the obvious international tensions.
To be clear, this is not a brilliant economic outlook. Somewhere out in the future there will be another global downturn. The conventional view that a left-leaning leader, such as Rayner, would alarm the markets is probably right. But there those two chinks of light in the dark clouds – clouds that look especially threatening for our current battered Government.
Need to know
It is for political commentators to figure out how long Starmer will last in post and whether it is likely to be Angela Rayner who will take over. My own view is that he may last longer than most people expect, simply because there are going to be so many damaging revelations from the Epstein disclosures that contenders would like him to take the heat of these before making their own challenge.
The markets seem to be taking that line too. The drama is over. Things have settled down on both the exchanges and the gilt market. As I noted above, we have had this before. Every time there is a negative event, gilt yields shoot up and sterling slumps. Most of these blows are self-inflicted: that first ill-received Budget, the Chancellor bursting into tears in the Commons or the recent threat to depose the PM. But a few are externally imposed, such as the “Liberation Day” tariffs of Donald Trump.
However – and this is important – both the currency and the bond markets swiftly revert to trend. That trend on the exchanges has been for sterling to strengthen slowly against the dollar, while the trend on the bond markets has been for gilt yields to remain within the quarter-point/half-point range with US treasury yields.
Simon French at Panmure Liberum has a neat graph here showing the premium on our borrowing costs, as measured by the spread between the yield on our 10-year gilts and the 10-year bonds of the next highest G7 country, currently the US.
That premium emerged around September 2024, a couple of months after the election but before Reeves’s first budget at the end of October that year. The frustrating thing, at least for the Government, is that the gap had been beginning to narrow over the past six months ( in fact, since her second budget). Her second bout of tax increases may be miserable for those of us who have to pay them but they did seem to calm the markets.
That is why I feel that a combination of tax increases (and it has to be one of the big ones, probably income tax) and better discipline over spending might be successful at cutting the premium. That would be the task for the next chancellor.
But this raises another question. Would even more tax and spend clobber growth? We can’t know the answer to that, but if you are going to put up taxes it is surely better to do so in a straightforward way, rather than making lots of smaller changes such as putting VAT on private schools fees, and using stealth measures, notably freezing tax thresholds.
As it happens there is a new British Social Attitudes survey that suggests that the public is turning against higher taxation and higher public spending. Support for increased spending on welfare benefits for the poor has fallen to 27 per cent, matching the lowest level ever recorded.
But changing the course of the benefits super-tanker will take a long time, and I can’t see this Government putting the helm over to start that shift. It will be a job for the next one, whoever forms it.
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