Sterling is falling, bond yields are rising sharply, and banking stocks are under pressure: UK markets are under strain. Deeply unpopular, Prime Minister Keir Starmer has just led the Labour Party to a heavy defeat in local elections, putting his political future at risk.
Although he is fighting to remain in office, his chances of staying in office appear limited, and investors are concerned about what could follow.
A loss of confidence with deep roots
Historically, markets have paid little attention to changes in the United Kingdom's Prime Minister.
David Cameron, Theresa May, Boris Johnson, Liz Truss, Rishi Sunak, Keir Starmer? The faces have changed, including a major political shift after 14 years of Conservative rule, but economic policy has remained broadly similar.
Investors have long given new leaders the benefit of the doubt, while punishing those who moved too far from fiscal orthodoxy, as Liz Truss experienced.
Brexit consequences are still felt
Today, however, the context is radically different. First, the British economy itself has weakened. By leaving the European Union (its main trading partner), the United Kingdom bet on a refocus towards the rest of the world, particularly the United States, just as the US was becoming more inward-looking on trade.
As a result, negotiating new agreements has proved difficult, and they are often less advantageous than those the country enjoyed within the EU.
Second, UK productivity remains structurally weak. Addressing this requires more investment. Yet convincing companies to invest in a market of 70 million consumers is far more difficult than when they had frictionless access to the entire European market.
Finally, the City of London has never fully recovered from the 2008 financial crisis. It has lost influence to centres such as New York.
This shift has consequences: when London was at the centre of global capital management, a significant share of those funds was invested in UK debt. Now, with flows shifting to New York or Dubai, that demand has eroded.
At the same time, the fiscal position has deteriorated. To attract capital, the United Kingdom must offer higher interest rates, which would increase the cost of credit across the economy, to the detriment of investment and the property market, a long-standing pillar of growth.
Mounting short-term concerns
The country appears stuck in what some call a "Great Stagnation". Since the financial crisis, growth has averaged barely 1%, compared with around 2.7% in the previous decade. The consequences are clear: weak wages, high inflation and a sharp rise in the cost of essential goods. British households have become poorer in real terms and now lag notably behind their European counterparts.
In this environment, dissatisfaction is growing. And in the absence of proposals from Keir Starmer considered ambitious enough, other voices are emerging. If the Prime Minister were to leave office, the Labour Party, still firmly in control of Parliament, would appoint his successor.
But the internal balance could shift: while Starmer represents a moderate line in the tradition of Tony Blair or Gordon Brown, his replacement could come from a more left-wing faction, advocating much more radical policies. Markets, therefore, fear fiscal slippage.
These political risks come on top of other threats: a possible resurgence of inflation linked to tensions in the Middle East, and a Bank of England that continues to reduce its balance sheet, limiting its support for the bond market. As a result, the 10-year yield has moved above 5.1%.
Longer-term fears are even stronger
Current tensions alone do not explain the surge in very long-term yields. The 30-year yield now exceeds 5.8%, a level not seen since 1998.
This signal reflects an even deeper concern: investors are not only worried about the next Prime Minister, but also about the one who may emerge from the next general election.
One signal is the big winner in the local elections, Nigel Farage's Reform Party. At this stage, many consider it likely that Reform could win the next general election, due by 2029 at the latest, and enter government.
Markets are not reassured by the party and its leader's populist orientation. The economic credibility of such a government remains uncertain.
Sterling is not as strong as the US Dollar
The surge in bond yields and the resulting fall in bond prices is very bad news for the country's banks. Their shares are volatile because they are among the main holders of UK debt.
This should alert London to an important reality: the United States can rely on the dollar's status to absorb sometimes bold policies without destabilising its bond market. The United Kingdom does not have that privilege.
Investors should keep reinforced caution
In this context, the United Kingdom is absent from our portfolios.
The rise in hydrocarbon and commodity prices may benefit some companies listed on the London Stock Exchange. But we favour a selective approach: we hold BAE Systems and Diageo, and retain Anglo American and Shell, which is listed in Amsterdam, among others.
In the bond market, despite attractive yields, we remain on the sidelines. Without a clear decline in inflation or a credible improvement in the fiscal position (a scenario that appears unlikely given the emerging political profiles), it is difficult to anticipate a lasting easing.
UK rates are likely to remain high for a prolonged period, with a significant risk of further increases if a government with radical policy positions comes to power. We are therefore monitoring the situation closely, but for now, we remain on the sidelines.
For our choices in asset allocation strategy, you may check Euroconsumers Invest's current portfolio: https://www.euroconsumersinvest.org/news/stocks-reach-new-highs-as-liquidity-holds