At some point in September, it looks like we’ll have a new Prime Minister in the UK (again). Andy Burnham will almost certainly be the seventh UK Prime Minister since 2016, and the fourth since Giorgia Meloni assumed that role in Italy in October 2022. With a certain weary resignation we ask, once again, what does this mean for financial markets.
On balance, our starting assumption is “not very much” in the short-term. We don’t think that the new Prime Minister has a set of exciting new levers that he can pull to achieve faster growth. Tax increases are probably on the table, but we suspect that the economic modelling might show that the fiscal benefits of significantly higher taxes won’t be compelling. So, the base case is more of the same, perhaps with a more optimistic tone than we got from Keir Starmer and Rachel Reeves.
Why do we think this? First, we believe that the tax burden in the UK is already high compared to history (measured as tax revenue as a percentage of GDP). The tax base is already quite narrow (a small percentage of households pay a relatively large percentage of income tax). Second, there’s the question of where economic growth comes from. We generally believe that the private sector drives economic activity, so increasing the role of the state beyond a certain point isn’t particularly productive.
Those are some of the things that underpin our thinking, but not everyone agrees. The new Prime Minister might have a different perspective and taxes could rise by more than we assume. But we do think that faced with the constraints of government, a new Prime Minister will probably conclude that there isn’t a long list of options for sustainably increasing tax revenue and accelerating economic growth in the short-term. The memory of Liz Truss still looms large.
One potential area of attention is around capital investment. While Burnham did say that he intended to keep the current fiscal rules, some of his informal advisors have argued that the fiscal rules should be adjusted to encourage more capital investment. We think this makes sense and that financial investors would be comfortable with that. It won’t shift the growth outlook today, but increased capital investment should generate faster growth in the future (and maybe more air-conditioning?).
Where does this get us? In the short-term, we think the new Prime Minister will be largely at the mercy of the global economy. The good news there is that oil prices have come down, which will hopefully provide some relief to energy bills in due course (although not at the next price reset in July). In terms of policy, we’d expect to see some tax increases, partly for the sake of appearances, but the impact on the fiscal accounts should be limited. We think there’s scope to encourage increased capital spending, and that should be a long-term positive – even if the cost of building infrastructure in the UK is horrendous. All of that means that UK yields should remain fairly well-anchored, which is probably fine for bond investors, but might create some disappointment a year from now for those hoping for a more profound change from a new leader.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
