Burnham is yet to lay out his policy platform in detail, but his reported pick for chancellor has reassured investors

Andy Burnham is set to be formally appointed as UK PM on Monday. He will inherit a mixed macro backdrop with resilient but volatile growth, persistently above-target inflation and a soft labour market. His government will have to navigate this in a relatively unforgiving fiscal environment with relatively high borrowing costs and a market which is highly sensitive to signs of fiscal slippage. 

We set out some initial thoughts on a Burnham premiership last month (see here). Since then, we haven’t learnt a great deal more about his policy platform. The core strategy will be regional rebalancing with devolved powers and a reallocation of capital investment away from London.

Burnham said today that he will be a “pro-business” leader in another nod to investors. His reported pick for chancellor, Shabana Mahmood, is significant in that regard Mahmood is from the right of the Labour party and, if confirmed, the selection suggests that Burnham is willing to balance his left-leaning instincts (which are stronger than Starmer’s) with market pragmatism. In terms of technical skills, Mahmood has limited financial or economic experience. But her stint in charge of the Home Office suggests competence and good political instincts. 

It will be difficult for the new government to break free from the cycle of Budget speculation

These skills will be required. Burnham has indicated he will retain the fiscal rules (outlined here) in their current form and it looks set to be a familiar tale of limited headroom and hard choices at the Autumn Budget. Borrowing has overshot the OBR’s March profile at the start of the fiscal year, and debt servicing costs have risen. Combined with the £5bn hole in the defence budget inherited from Starmer, we currently pencil in a figure of £15bn for the new chancellor to find in order to maintain the fiscal headroom of £24bn. (It’s worth stressing that this is an early estimate).

That is before we get into new spending pledges. Burnham has talked of measures to address “cost of living” pressures which might mean further household energy support. He has indicated a strong desire to increase capital investment in areas such as transport and housing, and continues to advocate the reversing the privatisation of utilities in some form.

It is possible that Burnham will try to seek more room for manoeuvre on capex within the existing fiscal framework. Using off-balance sheet structures which fall outside the relevant definition of debt has been mooted as one example. This sort of workaround might give some political cover, but borrowing is borrowing and markets will want to see transparency and a credible focus on productive capex. The OBR would also scrutinise any off-balance sheet structures carefully and would likely include them within its assessment of fiscal sustainability risks.

At any rate, it seems likely to us that Burnham’s government will be forced to shore up its fiscal position in the autumn with some consolidation measures. The list of options is quite familiar now after the government has been scratching around for revenue at consecutive Budgets. Possible measures could be another extension to the income tax threshold freeze, levies on specific sectors (e.g. banks), or targeting wealth via property or inheritance tax reform.

From a macro perspective, our concern is that speculation around possible tax rises will extend the ‘policy seasonality’ in UK growth data (see here). The UK is now in an annual cycle of pre-Budget speculation weighing on activity in H2 followed by a recovery at the start of the year.

That pattern was highlighted again in this week’s UK monthly GDP release for May with an upside surprise driven by robust services activity (the UK economy continues to demonstrate its resilience to the initial US-Iran energy shock). Taking into account a favourable revision to the historical data, we have revised our Q2 estimate up from 0.2 to 0.3% Q/Q, with risks tilted towards a higher figure. We now see annual growth at 1.2% this year. But it is likely to be a familiar story of fading momentum tailing off in H2. Recent survey evidence, especially in services, has been notably soft (the PMI slumped to a 41-month low). Domestic political uncertainty was cited as one headwind for activity. There is a risk that this will extend all the way to the autumn if Burnham struggles to contain Budget speculation.  

The BoE will be wary of any inflationary regulatory shifts

Meanwhile, the inflation story remains complicated. UK headline CPI rates have surprised to the downside by 0.2pp relative to consensus for two consecutive months with the May figure standing at 2.8%. The June figure will be released next week – we expect an unchanged figure (MUFG: 2.8%, cons: 2.7%) with lower energy costs offset by a higher core goods rate. We then see a step up above the 3% threshold from July following the 13.5% increase in the household energy price cap for the July-September period. Energy prices retraced after the US-Iran agreement but have partially rebounded since the deal effectively collapsed. That means less relief in terms of pump prices. With some further Hormuz-related pressures in the pipeline we currently see UK headline inflation peaking at 3.4% in Q4 this year.

The bigger picture here is that the UK is stuck in a higher inflation environment, which explains Burnham’s focus on the ‘cost of living’. The headline CPI rate has averaged 3.0% since the start of 2024. The BoE has not tightened policy, unlike the ECB, however. As well as the downside inflation surprises mentioned above there have been further signs of labour market slack and there has been scant evidence of any second-round price effects. The data flow has essentially made it impossible for the hawks to win the argument on the need for pre-emptive tightening.

Instead, the BoE will continue to rely on its “active hold” – that is, not cutting rates this year as was previously expected – to lean against inflation risks. We think this will remain tenable. Payroll employment, down 0.4% Y/Y in the latest data, remains on a general downward trend despite support from the public sector. Redundancy notification data suggests that upcoming labour market releases will remain soft. Uncertainty around Burnham’s policy platform may also weigh on sentiment.

In our central scenario we assume that the BoE will remain on hold this year. Hormuz-related energy developments pose the main risk to that call. But the BoE will also be watching closely for any sign of inflationary policies under Burnham. Officials will be particularly wary of regulatory changes which might contribute to higher employment costs and raise underlying price pressures.

To round off, our initial sense is that there will be a degree of continuity under Burnham. He is constrained by the election manifesto and seemingly recognises the importance of avoiding destabilising market sell-offs. But he also appears willing to probe at the limits of those constraints. It remains to be seen if Burnham’s government can reconcile its left-leaning instincts and regional investment ambitions with credible fiscal discipline at a time of elevated borrowing costs and inflation risks. The Autumn Budget will be a big early test of the government’s fiscal strategy and its broader economic credibility.

The ECB is happy to hold – for now

The ECB will meet on Thursday but appears content to defer the decision on further tightening until September when fresh staff projections will be available. We see one more hike to 2.50% in a ‘measured adjustment’ rather than a fully-fledged tightening cycle. See our full preview here: Happy to hold – for now. In terms of euro area data, our focus will be on the flash PMIs for July as we gauge the economy’s resilience and look for any signs of rising second-round inflation effects.

In the UK, as well as the obvious focus on incoming UK PM Burnham and his cabinet picks, there will be plenty of data out next week. We expect headline CPI will remain unchanged and there will be further signs of labour market softness, bolstering our call for the BoE to remain on hold despite the recent uptick in energy pricing. Meanwhile, the government will hope for a better batch of public finance numbers and signs of improving services output in the flash PMIs.