Why Britain’s Economy Is Stuck: The Tension Between Voters and Bond Markets
The days of two-party politics in the UK are over. When voters go to the polls in England next week, they will have five main contenders to choose from. In Scotland and Wales, nationalists make it a six-strong race. This fragmentation reflects deep discontent with Labour and the Conservatives. One thing in common between the Greens and Reform UK is that they benefit from a sense that radical parties are worth a punt because nothing could be worse than it is now.
That’s not necessarily the case. Inflation is on the rise due to the war in Iran. Mortgages are becoming more expensive. The likelihood is that the economy’s strong start to 2026 will not be sustained. No question, things could turn very nasty indeed. Faced with a new cost of living crisis, the government has a dilemma. There is a mismatch between what would be popular—subsidies to reduce energy bills, for example—and what the Treasury thinks the country can afford.
The Bond Market’s Stranglehold on Politics
In theory, that dilemma should not exist, because a government that issues its own currency has no limits on what it can spend. In practice, though, governments submit to the discipline imposed by financial markets. There is no such thing as the Bond Dealers party, but there might as well be, because the people who trade in UK government debt exert a stranglehold on politics.
It works like this: The government sells bonds to investors to finance its borrowing. Investors are paid interest, which varies according to risk. The higher the risk, the higher the interest rate investors demand. Risk can come in various forms—fear of rising inflation or political concerns that a government pledged to financial probity will be replaced by a spendthrift administration.
Markets currently believe the UK faces both these risks, which is why the interest rate—or yield—on government bonds has risen above 5% to levels not seen since the 2008 financial crisis and higher than in any other G7 country. The bond markets think the Peter Mandelson saga has made it more likely that Keir Starmer will be replaced as prime minister and are making it clear that they don’t want his successor to borrow more to mitigate cost of living pressures.
Historical Precedents and Political Crises
That may just be one of the few things that could save Starmer, because Labour has plenty of form when it comes to midterm financial crises, starting with the collapse of the minority Ramsay MacDonald government in 1931. The classic example is the 1976 sterling crisis that led to a bailout from the International Monetary Fund, also triggered by a surge in inflation from an energy shock.
The Conservatives have also had their problems with the markets, most recently those caused by Liz Truss’s short-lived government in 2022. It wasn’t just the spectacularly ill-judged budget; it was also that the markets were not warned about what Truss and her chancellor, Kwasi Kwarteng, were planning. The revenge of bond dealers was swift and brutal. They demanded action to reduce borrowing, and that’s what they got. First Rishi Sunak’s government and now Starmer’s have raised taxes, which are currently at their highest level since the immediate aftermath of World War II. But borrowing remains high, and growth—even before the Iran war—was sluggish.
Limited Choices for the Government
The choices facing this or any future government are limited. It can welcome the discipline imposed by the markets, accepting that previous crises make action to repair the public finances inevitable. The hope is that bond dealers will be impressed by fiscal rectitude, lowering debt interest payments and freeing money for welfare, defence, and the NHS.
This sums up the approach of the current chancellor, Rachel Reeves. She changed the rules governing government borrowing to permit an increase in public investment and has taxed more to spend more. Yet she thinks there are constraints on what she can do.
Whether submitting to the bond markets is right for the economy or the country is another matter. Britain has an ageing population that needs care, ambitious plans to decarbonise, and pledges to spend more on defence. A return to pre-financial crisis growth levels would help pay for these things but is not in prospect. Indeed, one reason for political splintering is the economy’s failure to regain its mojo. Part of the Green party’s appeal to disenchanted Labour voters is the sense that taking back control from the markets would be no bad thing if it allowed extra borrowing for long-term investment.
As things stand, the chances of this happening are remote. Parties in power, recently in power, or aspiring to power tend to be more aware of the risks of taking on the bond markets. And make no mistake: those risks are real. But so are the risks of letting the bond markets decide that—whichever party voters choose—nothing really changes.
