The days of two-party politics 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, the nationalists make it a six-strong race.
This fragmentation reflects the deep discontent with Labour and the Conservatives. One thing in common between the Greens and Reform UK is that they are each benefiting 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.
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 on them by the 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 in order to finance its borrowing. The investors are paid interest, which varies according to the risk involved. The higher the risk, the higher the interest rate investors demand. The risk can come in a variety of forms. It may be that the bond markets fear that inflation is about to rise sharply. Sometimes the perceived risk is political, with 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 be someone who wants to borrow more in order to mitigate the cost of living pressures faced by voters.
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 eventually led to a bailout from the International Monetary Fund. That, too, was the result of a surge in inflation caused by 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 fact that there was a spectacularly ill-judged budget, although that certainly was the case. It was also that the markets were not warned in advice 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 the second world war. But borrowing remains high, and growth – even before the Iran war – was sluggish.
The choices facing this or any future government are limited. It can welcome the discipline imposed by the markets, accepting that the impact of previous crises has made action to repair the public finances inevitable. The hope is that bond dealers will be impressed by a display of fiscal rectitude and that lower debt interest payments will leave more money available for welfare, defence and the NHS.
This pretty much sums up the approach followed by the current chancellor. Rachel Reeves changed the rules governing government borrowing to permit an increase in public investment, and she has taxed more in order 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 for the country is another matter. Britain has an ageing population that will need to be cared for. It has ambitious plans to decarbonise. It has pledged to spend more money on defence. A return to the pre-financial crisis growth levels would help pay for all these things but is not really in prospect. Indeed, one reason for the splintering of politics has been the failure of the economy to get its mojo back. 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 that are in power, have recently been in power or aspire to being in 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, too, are the risks of letting the bond markets decide that – whichever party voters choose – nothing really changes.
Larry Elliott is a Guardian columnist
