The fragmentation of British politics, with five main contenders in England and six in Scotland and Wales, reflects deep discontent with Labour and the Conservatives. Both Reform UK and the Greens are benefiting from a sense that radical change is worth a try, as nothing could be worse than the current situation. However, the economy faces new pressures: inflation is rising due to the war in Iran, mortgages are becoming more expensive, and the strong start to 2026 is unlikely to be sustained.
The government faces a dilemma between what would be popular—such as subsidies to reduce energy bills—and what the Treasury believes the country can afford. In theory, a government that issues its own currency has no limits on spending, but in practice, it submits to the discipline of financial markets. The bond dealers, who trade in UK government debt, exert a stranglehold on politics. When the government sells bonds to finance borrowing, investors demand higher interest rates if they perceive higher risk, whether from inflation or political instability.
Currently, markets believe the UK faces both risks, pushing bond yields above 5% for the first time since the 2008 financial crisis—higher than in any other G7 country. The bond markets view the Peter Mandelson saga as increasing the likelihood that Keir Starmer will be replaced as prime minister, and they are signalling opposition to a successor who would borrow more to ease cost-of-living pressures. This may ironically help Starmer, as Labour has a history of midterm financial crises, such as the 1931 collapse of Ramsay MacDonald's government and the 1976 sterling crisis that led to an IMF bailout.
The Conservatives also faced market backlash, most notably during Liz Truss's short-lived government in 2022, when a poorly judged budget and lack of prior warning led to swift and brutal demands for reduced borrowing. Both Rishi Sunak's and Keir Starmer's governments have since raised taxes to their highest level since the aftermath of World War II, yet borrowing remains high and growth—even before the Iran war—was sluggish.
The choices for any future government are limited. It can accept market discipline, hoping that fiscal rectitude will lower debt interest payments and free up money for welfare, defence, and the NHS. This is essentially the approach of Chancellor Rachel Reeves, who changed borrowing rules to allow more public investment and taxed more to spend more. However, whether submitting to bond markets is right for the economy or the country remains an open question.
