Following Keir Starmer’s resignation as Leader of the Labour Party and Prime Minister, Dan Coatsworth, Head of Markets at AJ Bell, has shared five key areas for investors to keep an eye on in the coming months.
Don’t be fooled into a false sense of security from today’s muted bond market reaction to Keir Starmer’s resignation. There is still a risk that bond markets find something to worry about as we transition to a new prime minister.
It could just be a momentary stillness before things escalate. Here are five key areas to watch.
- Leadership battle?
Uncertainty is the enemy of financial markets and investors prefer clarity over a guessing game. Keir Starmer resigning as prime minister is only the first step towards a new political era. We still don’t know who the next prime minister will be, and whether there will be a coronation or a leadership contest.
Wes Streeting’s decision to back Andy Burnham rather than mount a leadership challenge has lowered the chances of a battle to get the keys to Number 10. It removes the only other person who has publicly expressed a desire for the top job.
Others may still throw their hat into the ring before nominations close for Labour’s new leader on 16 July, hence why investors cannot readjust expectations with confidence just yet. The market will be watching closely for any indication there is a serious rival for the Labour leadership to Burnham, and whether they would have enough support from party members to succeed.
- Fiscal credibility concerns
Chancellor Rachel Reeves spent a long time trying to win over the market with her plans to get the public finances in a better shape. It was a hard battle which she eventually won, and now there is potential for the game plan to be ripped up if she is replaced and fiscal credibility worries re-emerge.
While Burnham has been light on policy details to date, there is growing speculation that he might increase public spending if he becomes prime minister.
So far, he has signalled an intention to maintain Reeves’ fiscal rules and Labour pledges on income tax, National Insurance and VAT. The big unknown is whether he would stick to these points should he become prime minister, or whether they were just loose remarks to smooth the path to the top.
The bond market would worry about how any change in spending plans might be funded, and whether any decision to raise taxes would dampen already lacklustre economic growth.
That could lead to higher gilt yields which makes it more expensive for the government to borrow money, and that also feeds into the pricing of mortgages and corporate loans. The trickle-down effect could be negative business and consumer sentiment and a weaker jobs market. In that situation, the Bank of England’s attention would switch from the current inflation concerns to loosening monetary policy to prop up the economy, implying yet another shift in interest rate expectations.
Were that to happen, the UK would become higher risk from an investment perspective and that could hurt the pound and stop the overseas investor revival in its tracks. Foreign investors turned their back on the UK after the Brexit vote and only started to regain interest a few years ago.
- Chancellor choice
Bond markets would welcome Rachel Reeves staying as chancellor as continuity implies consistency with current fiscal policies. Unfortunately, Reeves has such a strong association with Starmer’s way of doing things that she may struggle to keep her job. Just as a new chief executive is often followed by a change in chief financial officer for large companies, the same refresh can happen in politics.
Fixed income investors will be quick to judge a new chancellor on whether they are a cautious or adventurous type of person. Bond markets want a cautious type, and someone determined to balance the books. They wouldn’t want someone ratcheting up the spending without enough thought to whether the country can afford it.
Equity investors will be hoping for a more pro-business chancellor than Reeves, as she has presided over considerable cost pressures on UK industries over the past two years.
- Nationalising utilities – what would this mean for public finances?
Andy Burnham has indicated that water and energy providers should be placed under public control. The utilities industry has come under much criticism in recent years for delivering a poor performance while paying big dividends to shareholders.
Nationalising key public service providers would give the government control of companies to improve service quality and plough back any positive returns from customer payments into public finances.
It’s easier said than done. Utilities require significant ongoing investment and bond markets will want to know how this will be funded, as well as how any nationalisation programme would work and the scale of existing debt liabilities being inherited.
The government would probably have to issue a massive number of gilts, further increasing supply, and in doing so would probably lead to higher gilt yields as investors demand a greater risk premium if the country’s borrowing levels go up.
- Potential delays to the Budget
There is a risk that it takes a new prime minister, and potentially a new chancellor, several months to finalise their policies. They will want to make their mark and show they are taking the country in a different direction than Starmer’s administration. That means reshaping plans and making sure decisions are the right ones.
Convention says the chancellor must give the OBR at least 10 weeks’ notice of a Budget and fully costed policy proposals, so the public body has time to produce economic forecasts. Given that a new prime minister may not be in the hot seat until the end of the summer, the Budget could feasibly be pushed back to later in the year.
“Markets hate delays to the Budget as it allows for more speculation over what might be in it. This dynamic played out in the weeks and months preceding last year’s late November Budget, which saw rampant speculation around the fate of pension tax incentives lead to scores of savers making hasty, often irreversible decisions to access their pensions early.
