Politics brief: can Starmer deliver?

In keeping with precedent, Labour Prime Minister Keir Starmer looks likely to leave the bulk of economic policy making to his Chancellor Rachel Reeves. Her self-titled approach, so-called ‘securonomics’, contains a wide range of initiatives, many of which look sensible in our view. These include:

• the re-writing of planning laws to try to increase housing supply;
• no increases in income or corporation taxes;
• budget discipline with a stronger role for the independent Office for Budget Responsibility – the government’s fiscal watchdog;
• new initiatives to increase capital investment in clean energy; and
• new legislation to encourage pension funds to invest more in the UK.

If Starmer and Reeves manage to enact most or all of these policies, the resulting improvement in long-run investment can lift UK growth potential. However, some aspects of their agenda look somewhat misguided. For instance, Starmer and Reeves also pledge to increase minimum wages and expand workers’ rights.

While such labour market policies are no doubt well intentioned, if taken too far, they carry at least three risks. First, if firms simply pass on their higher wage costs to final prices, that would mitigate any positive effect on the prevailing level of average real wages. Second, higher wage costs that are not matched by improvements in worker productivity encourage firms to substitute capital for labour, creating unemployment. Third, in case minimum wage hikes impose an excessively high wage floor on the labour market, they can impede the crucial process of labour market clearing via falling wages in case of future recessions that cause a rise in unemployment. Instead of raising living standards and making jobs more secure, such initiatives can have the opposite effect.

At this early stage, it remains an open question whether Starmer and Reeves can deliver on all of their promises. But after winning almost two-thirds of the seats in the House of Commons, Starmer probably has the momentum and political capital to drive through some difficult reforms, especially on planning. In addition, thanks to his big majority, Starmer should not need to rely much on the far left of his party to pass legislation. This may contain the risk that he pushes too hard on counterproductive labour market policies.

Remember Blair?

If history is any guide, Starmer’s mostly pro-growth and pro-European tilt can go down well with financial markets. In May 1997, Tony Blair’s New Labour won a landslide election after 18 years of Conservative rule. Blair and his Chancellor Gordon Brown inherited an economy on the rebound after a bout of inflation and high interest rates had toppled the economy in the early 1990s. Sound familiar?

Although the UK fiscal backdrop is more challenging today than in 1997 – see ‘In Focus – UK fiscal policy’ on page 10, and potential growth is lower, a similar combination of stable politics, a recovery tailwind and rising confidence can lift sterling and improve the mood in UK markets. In the run up to Blair’s win, which markets had anticipated, and in the months that followed, sterling surged (Figure 9, page 7) while UK stocks rallied. After a recent uptick on the back of fading uncertainty, we project that sterling will rise by c.9% against the dollar to 1.40 by the end of 2026 and by c.5% against the euro t0 1.24 over the same period.

Although there is little room for a debt-financed fiscal stimulus near term, two years of economic growth at moderate inflation may give Starmer and Reeves some scope to ease the purse strings from 2026 onwards.

In focus: UK fiscal policy

Labour Prime Minister Keir Starmer and his Chancellor Rachel Reeves inherit a difficult fiscal situation, to put it mildly. Although the public deficit at c.3% of GDP is in the safe zone and falling on trend, high public debt at close to 100% of GDP constrains the capacity for future borrowing. In addition, years of mismanagement have left a situation in which fiscal policy and the public sector more broadly frustrate UK growth potential.

• As a share of GDP, taxes have risen to their highest level in 50 years and still fall short of fully financing the ballooning public sector (Figure 1).
• Public sector productivity has been virtually stagnant since 1997.
• Public investment makes up just 5% of total spending and has not risen much as the overall share of government spending has increased.
• The link between social benefits and unemployment is breaking down – falling unemployment no longer reduces social benefits spending.

Figure 1: UK Government spending and receipts

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Kallum Pickering

Chief Economist