Political change, fiscal continuity?

There is no doubt that the summer of 2026 will be remembered for two things: the remarkable run of sunshine in the UK and the relative smoothness of the Labour Party’s leadership transition.

Recent history suggests that political successions are rarely straightforward. The Conservatives experienced a turbulent sequence of changes from Cameron to May, May to Johnson, Johnson to Truss and Truss to Sunak, with Liz Truss’s tenure becoming synonymous with market instability.

By contrast, Labour’s transition has so far appeared remarkably orderly. The party has rallied behind one of its own, and Andy Burnham has undoubtedly proved effective at articulating a vision for government, even if that vision is often wrapped in the same political clichés and platitudes familiar to all administrations.

However, one of the defining messages of the new government’s early days was its insistence that the fiscal rules would remain unchanged. That commitment now appears slightly less unequivocal. Chancellor John Healey has already spoken of the scope for “more and more rapid investment”, while Treasury officials are understood to be examining flexibility within the existing fiscal framework rather than treating the rules as immovable constraints.

The challenge, as always, is that policy ambitions rarely come free of charge.

The cost of early commitments

Among the measures announced so far:

• The much-discussed £2 bus fare cap is expected to cost approximately £450-500 million.
• The temporary removal of VAT on household electricity bills is expected to reduce Treasury revenues by around £850 million.
• The reduction in business rates for pubs, clubs and grassroots music venues is unlikely to be fiscally material in the context of overall public spending, but it is nonetheless another revenue giveaway.

Beyond these sit a number of proposals for which no meaningful costings have yet been published:

• Ending rough sleeping.
• A large-scale council house building programme.
• Greater public control or ownership of utilities.
• The establishment of “No.10 North”.
• Further devolution of powers and resources to local government.

While individually these may be manageable, collectively they point towards a government with a significantly more interventionist agenda than its predecessor. Some of these proposals also imply the creation of additional administrative structures and ongoing operating costs.

The defence spending dilemma

Healey’s appointment as Chancellor adds another dimension. Before entering the Treasury, he resigned as Defence Secretary arguing that the Armed Forces were not receiving the funding they required. At the time, reports suggested the Ministry of Defence had sought approximately £18 billion over four years, while the Treasury was prepared to provide only £13.5 billion, leaving a funding gap of around £4.5 billion. Even that level of funding remained well short of the trajectory needed to reach NATO’s 3.5% of GDP defence spending aspiration by 2035.

Some of the new spending commitments have been accompanied by funding offsets. The government has pointed to the cancellation of the Digital ID programme and changes to international climate-finance allocations as examples. However, these measures largely represent reallocations rather than a solution to the broader fiscal pressures building elsewhere in the system.

At the same time, the scope for further significant tax increases appears limited. Total government receipts are now running at around 40% of GDP, levels not seen consistently since the early 1980s. Tax revenues alone account for approximately 36% of GDP, up from around 28-29% in the early 1990s.

Debt costs remain a constraint

The debt-service burden is equally important. UK government debt-interest costs are expected to reach approximately £111 billion in 2025/26, equivalent to around 3.7% of GDP and more than 8% of total public spending. With 10-year gilt yields still hovering around 5%, the prospect of materially lower debt-servicing costs appears remote. Unless economic growth accelerates meaningfully, the most effective route to reducing that burden would be sustained fiscal surpluses; a scenario that currently appears unlikely.

Alongside these fiscal pressures, the government must still contend with the politically sensitive issues of welfare spending, prison overcrowding and immigration before the next general election. The new administration is walking a tightrope, and fixed-income investors will be watching closely.

The case against lower bond yields

Markets do not always require bond vigilantes to impose discipline. Sometimes all that is needed is a greater supply of bonds than investors are willing to absorb at prevailing prices.

Combined with the broader trends we have discussed previously namely deglobalisation, higher defence spending and expanding fiscal policy across much of the developed world, the case for structurally lower bond yields appears increasingly weak.

As fixed-income investors, we continue to believe that duration should be viewed primarily as a source of risk rather than a portfolio hedge. Consequently, we remain structurally underweight duration across our strategies and expect to maintain that positioning for the foreseeable future.

We are conscious that the ending of quantitative tightening could be a catalyst for even a duration rally, which we are keeping an eye on. However, outside of this, the thesis remains, and duration should firmly be seen as a risk rather than a hedge over the medium term.

Simon Prior
Fixed Income Fund Manager