By David Rees, Head of Global Economics at Schroders
The UK's intractable problems mean it will be difficult for a new PM and Chancellor to invest for growth and maintain market confidence.
Financial markets have so far taken Keir Starmer's resignation in their stride, reflecting the degree to which a change in Labour leadership had become increasingly conceivable following Andy Burnham's convincing by-election victory in Makerfield.
It remains to be seen whether another contender will emerge for the leadership, or whether Burnham's margin of victory provides a template for Labour to secure a second term in government. After all, whoever becomes the next Prime Minister will still have to overcome the challenge of delivering stronger economic growth and improving living standards.
The UK’s low potential rate of growth, constrained public finances and elevated inflation mean there are no easy answers. Raising investment and productivity remains the most credible long-term solution, but this requires time and sustained political commitment. The benefits are also unlikely to be felt quickly.
That may ultimately require changes to the fiscal framework. Ideas such as removing defence spending or capital investment from the fiscal rules have some merit, but they also risk being perceived as a loosening of fiscal discipline.
Any suggestion of that could push gilt yields higher and place pressure on the government to reverse course. As a result, whoever becomes Chancellor will need to tread a very careful path between supporting growth and maintaining market confidence.
Sterling also looks vulnerable. We already see the pound as exposed to any reversal in market expectations for further increases in Bank Rate. Soft underlying economic activity suggests that the current energy price shock is unlikely to translate into sustained second-round effects, while any deterioration in confidence in the gilt market would only compound those underlying pressures.
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