Andy Burnham vs the Bond Market

With Andy Burnham winning the Makerfield by-election last night, champagne will no doubt be flowing for the Socialist King in the North. But for this economically illiterate Labour Government, further trouble is expected. The fellows with the actual money, otherwise known as bond traders, are listening very closely to what the possible new Prime Minister is saying – and the cost of UK Government borrowing rose faster than anywhere else in Europe after Burnham secured his by-election victory this morning.

When Burnham warned last year that Britain was too “in hock” to the bond market, the hopeful Labour leader gave an insight into his real feelings, but unsurprisingly, the market fought back immediately. The moment leadership speculation flared up, traders priced in the risk of an even more spendthrift Prime Minister and gilt yields rose. By May 15th, the 10-year gilt yield had soared to a high of 5.19%, levels not seen since 2008 (during another Labour government’s economic masterclass).

Burnham has since insisted he was misunderstood and would like his comments struck from the record, but walking back a remark is not the same as proving you didn’t mean it. The key question is whether the markets will continue to demand a higher and higher yield as a condition of holding British debt as Burnham circles Downing St – and I think I know the answer.

While a Labour hold in Makerfield would normally be read by the markets as a sign of stability, Burnham’s win sends the opposite signal. It elevates his profile, fuels speculation about a leadership contest, and almost certainly means a tilt towards more welfare spending, whether he pulls off a leadership coup or not. Burnham is an obvious fan of greater public investment, regional spending and a bigger role for the state, as are many of his supporters on the Labour backbenches. The issue for investors is not uncertainty in the abstract but whether more public spending, which now feels inevitable, will require significantly higher borrowing.

Investors are unlikely to welcome the prospect of an internal leadership challenge at a time when the UK’s public finances are at breaking point and the national debt has never been higher. Markets value certainty, and with a Burnham win, they can now focus more closely on the prospect of higher future borrowing. If gilt yields continue to rise, the cost of servicing Britain’s national debt rises with them, leaving less room for new spending commitments. For a politician advocating greater public investment, this creates an obvious constraint. Should investors conclude that a Burnham-led government will loosen fiscal discipline, higher gilt yields could quickly erode the vanishing financial headroom needed to fund those promises. In effect, the bond market would be imposing limits on Labour’s spending plans long before any legislation reached Parliament.

The dilemma for Burnham is that the policies most likely to excite his political base are the same policies that attract the closest scrutiny from bond investors. Large-scale regional investment programmes may be politically popular, but the market’s first question is always, how they will be paid for? Without a credible plan to fund additional spending, investors are likely to assume that borrowing will do the heavy lifting. In the current fiscal climate, that assumption alone is enough to push gilt yields up.

The bond market now sits as a kind of parsimonious bank manager standing over all our spendthrift politicians. For the leader of the Green Party, Zack Polanski, basic economics is beyond his grasp, but for the more serious politicians, such as Reform UK’s Robert Jenrick, any extra spending must be balanced against savings made elsewhere. Reform has pledged to increase spending, primarily in the NHS and defence, but it has also pledged to cut spending across a raft of areas, such as Net Zero, welfare and foreign aid – although whether it would be able to make those cuts is an open question.

From the perspective of the gilt market, the distinction is simple. Investors are less concerned by spending itself than by whether and how it’s funded. Governments that combine higher expenditure with credible savings – or, God forbid, higher taxes – generally attract less scrutiny than those relying solely on additional borrowing.

The North’s new self-appointed King may have won a new crown in Makerfield, but as the bond market starts flexing its powerful muscles, he could find that crown sits very heavily on his head.

Harry Morrison has worked as an investment analyst for the last seven years, specialising in investment research for financial services clients.

Stop Press: The Conservatives have won a historic shock victory in Aberdeen South by more than 6,000 votes, vindicating Tory leader Kemi Badenoch’s declaring the by-election a “referendum” on North Sea oil and gas.