David McNamara: UK markets fear for Keir Starmer successor
British prime minister Keir Starmer leaves number 10 Downing Street. Picture: PA
While the crisis in the Middle East rumbles on, political machinations in the UK have provided a further hit to UK asset prices last week. Following poor local election results, British prime minister Keir Starmer has faced several ministerial resignations, including most notably, his health secretary Wes Streeting.
It now appears Mr Streeting will be among a number of leadership challengers to Starmer, albeit each face a high bar of 81 MPs to enter a contest. Mr Starmer has insisted he will fight an eventual leadership election.
These political developments are now crystallising in rising UK bond yields and a fall in sterling and UK equities. UK gilt yields are over 20 basis points (bps) higher across the curve since the election and 60-90 bps higher since the end of February, before the Iran conflict.
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Investors appear to be pricing in more profligate fiscal policy, given the cast of potential new leaders. In particular, the frontrunner Andy Burnham recently commented that the country shouldn’t be “in hock to the bond markets”. While these comments might reflect the nature of the audience, the risks to fiscal policy are now being priced in by investors, including whether current British chancellor Rachel Reeves may be replaced.
The UK’s fiscal situation has been strained by both the political uncertainty and its exposure to rising energy prices. A further large support package of energy subsidies, as was implemented in 2022, risks widening the deficit and deteriorating the debt position. In 2022-23, European governments, on average, spent nearly 3% of GDP on energy support packages. In the UK, the figure was 4.5% of GDP, but this is unlikely to be repeated to the same extent, given the current constraints.
While the UK imports just under 50% of its annual energy requirement, less than other G7 countries, it relies on fossil fuels for 77% of its energy and has been slower to deploy nuclear and renewables than some European peers, leaving it exposed to global swings in energy prices. In the period 2025-26, the Government is expected to run a fiscal deficit of nearly 4.5% of national income, falling steadily in subsequent years, according to recent Budget forecasts. Net debt is expected to remain around 96% of GDP over the same period. However, the near-term fiscal forecasts were finalised before the Middle East conflict drove the initial surge in UK borrowing costs.
This may leave a future prime minister in an even more fiscally constrained position than Mr Starmer faces today, despite the spending promises that will be floated in the coming months by the prospective candidates. Perhaps then, any potential challengers need to be wary of not promising too much, for fear of placing undue fiscal strain on the economy, or for under delivering ahead of the next general election, due some time in 2029.
