Goldman Sachs: Bank of England unlikely to raise interest rates if new Labour PM boosted spending
A change of Labour leader, and a boost to government spending, is not likely to prompt the Bank of England to raise interest rates, Goldman Sachs argues.
In a new research note this morning, Goldman Sachs economist James Moberly argues that there are “no immediate implications from higher political risk” for the BoE’s monetary policy committee (MPC), which sets interest rates.
He writes:
We see no immediate implications from higher political risk for the BoE. It is possible, of course, that more expansionary fiscal policy under a new Labour leadership boosts demand and inflation, and therefore eventually requires tighter monetary policy.
But our previous analysis does not support the idea that the MPC has historically responded to signs of political risk by raising Bank Rate, for example, in an effort to support the currency.
That suggests that Andy Burnham, for example, could push for higher spending without the risk that the Bank responded swiftly by hiking interest rates.
Burnham has argued that there is a case to consider defence spending outside of the existing fiscal rules, which could allow more overall borrowing.
But, as Goldman Sachs point out, any prime minister’s policy choices will” remain constrained by the challenging backdrop of rising spending pressures and an already elevated tax burden.”
Moberly also explains that “the bulk of the selloff” in UK government bonds since the Iran war started is because investors have repriced the outlook for UK interest rates, rather than due to political risks.
He expects the Bank of England will leave interest rates on hold this year, although if energy price pressures keep building it could raise borrowing costs this summer.
UK bond yields fall after Streeting challenge to Starmer fails to materialise
UK government bond prices are rallying at the start of trading, pulling down borrowing costs.
Investors appear relieved that Sir Keir Starmer is holding onto power this morning, after a challenge from health secretary Wes Streeting failed to materialise.
The yield, or interest rate, on 30-year UK government bonds has dropped by 4.4 basis points (0.044 of a percentage point) in early trading to 5.72%. Yesterday it hit a 28-year high of 5.81%, before a small recovery as Starmer faced down the threat of a cabinet rebellion.
Benchmark 10-year UK bond yields are dropping too – down 4bps to 5.06%, so still over the 5% mark.
These are relatively small moves in borrowing costs, but crucially for Downing Street they show that some calm is returning to the bond market.
As our politics team reported last night:
Streeting was due to hold talks with Starmer on Wednesday, at which he was expected to talk candidly about his concerns, with No 10 insiders suggesting he was climbing down from intense speculation that he was on the brink of running.
Lloyd Harris, head of fixed income at Premier Miton Investors, argues that the ‘Starmer drama’ shows that the key issue is government credibility.
The Labour Party is not driven by one individual. It is shaped by its internal dynamics and by its union base, both of which tend to favour a more expansive fiscal stance. Markets understand this. They do not price the best-case scenario, they price the probability weighted outcome. Where fiscal discipline risks giving way to political pressure, yields adjust accordingly.
The reaction to Andy Burnham’s comments was telling. His remark that the UK has to “get beyond this thing of being in hock to the bond markets” reflects a strand of thinking within the party that markets instinctively reject, not the rhetoric itself, but for what it implies about relaxing fiscal constraints.
Bond markets do not need to be challenged; they need to be convinced. When policy signals suggest those constraints may be ignored, investors respond through pricing. Often labelled as bond vigilantes, but in reality, it is a straightforward repricing of risk.
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IS THE UK THE HARBINGER OF THINGS TO COME?
That’s the eyecatching title of a new note from City firm TS Lombard this morning, who point out that Britain has been suffering under the new ‘macro supercyle’ (which incudes the new multipolar global order, increased conflict, and more interventionist national policies).
TS Lombard economists explain:
The UK has frontrun all the downsides of the new macro regime and none of the upsides
We see little hope of the UK catching the upsides any time soon
Political volatility will continue to reign in the next few months
But risks of a blowout budget seem overdone
And the UK is closest to the brink of recession if the Middle East shock rolls on
Last night, former hedge fund manager Rich McDonald warned that a long, drawn-out process to replace Keir Starmer as PM would be bad for the markets.
McDonald, who hosts IG’s podcast The Art of Investing, told Tonight with Andrew Marr on LBC that further weakness in the bond market would cost the country money.
“If we saw, let’s say Andy Burnham decided to run and there was some talk of a move to the left and more spending, I don’t think that would be taken well. And therefore, the bond market would give out a warning, right? If we see yields go anywhere near 6%, that that’s going to really scare people and it’s going to put up the cost of spending that we already have on our large debt position.”
McDonald argued that yesterday’s jump in borrowing costs (in which the 30-year bond yield hit 5.8%) was “awful”, explaining:
“We saw the long gilts rise to the highest yields that we’ve seen in almost 30 years, and they have a very strong message for Labour. Get your house in order.”
Introduction: Bond market on edge after Tuesday's wobbles
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
The UK bond market is bruised this morning after a day of political turbulence drove up Britain’s borrowing costs.
UK long-term bond yields hit their highest levels in 28 years on Tuesday, as fears about a change of Labour leadership triggered investor jitters and warnings of further bond market turmoil.
But this morning, Keir Starmer remains in post having fought back against pressure to lay out a departure timetable, with health secretary Wes Streeting not (yet, anyway) having launched a challenge.
Many investors have warned that if Labour tilted to the left, the bond market would balk at the prospect of higher borrowing and spending.
But the prospect of Reform winning the next election, and Nigel Farage entering Downing Street, appears to also be a factor pushing up yields, after the party made gains in last week’s local elections.
Ipek Ozkardeskaya, senior analyst at Swissquote, explains this morning:
Brits are grappling with their own political shakeups after Nigel Farage scored big in the latest elections. The name Farage resonates in markets as a clearer path toward looser fiscal policy, higher spending and larger deficits, just as investors are already worried about Britain’s debt and inflation outlook.
That combination is pushing investors to demand higher compensation to hold UK government debt, sending the UK 10-year gilt yield back above 5%. That’s the highest level since 1998. The higher the borrowing costs, the less the government can borrow, and the impact on growth would be negative.
Yesterday’s sharp moves in bond markets were clearly triggered by the crisis gripping the Labour government, with Streeting supporters pushing for a swift resolution, while allies of Greater Manchester mayor Andy Burnham arguing he’s the answer to the current malaise (if he could return to parliament)
But earlier this week, market strategist Bill Blain of Wind Shift Capital argued that investors might not see Reform as a ‘safe pair of hands’, writing:
Who in Reform is going to run the bond market / spending plan optimisation game? What are they going to do to solve the housing crisis – which isn’t about building 1.5 mm executive homes in the next 3 years but about supplying decent social and affordable housing for young people to have housing security and start family formation? Who in Reform will be looking at the welfare budget (which now pays £39 bln (2/3 of the defence budget) on housing benefits? Who in Reform will be making the calls on the NHS, Defence and, yes, the greatest immediate challenge to England since the Armada hove into view – filling potholes?
Reform has clear intent to govern. Over the next three years – how will they persuade the bond market they can?
The UK government will outline its legislative plans today in the King’s Speech, which could also bring Starmer some respite from troublesome ministerial resignations and demands for his resignation.
The agenda
10am BST: IEA monthly oil market report
10am BST: Eurozone GDP report (latest estimate for Q1 2026)
1.30pm BST: US producer prices inflation report for April
3pm BST: Bank of England policymaker Catherine L Mann to release speech on ‘The UK’s international exposures and vulnerabilities’
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