England fans are dreaming of bringing football home. Investors on the other hand are simply hoping gilt yields stay where they are. While one national drama will be decided on the pitch this week, the other looks all but settled. Barring a heroic last-minute comeback, worthy of a World Cup semi-final, Andy Burnham will become the UK's next prime minister.

There are scant details of his economic policy agenda, but we know the broad themes he is likely to pursue over the next three years. There will be a push towards a more decentralised, bigger and more interventionist state. In practice, that will mean higher taxes, spending and borrowing, which is likely to result in relatively higher interest rates. There will also be a clear push to give regional governments more power, while the trend towards greater regulation will probably accelerate. However, it may also make some desperately needed reforms, especially to planning regulations. That could be a significant positive.

The result is likely to be some near-term volatility as markets assess who the next chancellor will be and the tax and borrowing policies they will implement. Longer-term plans, such as the renationalisation of utilities and devolution, may be politically popular, but they are unlikely to make much difference to businesses or the economy this decade.

Reeves out, but who’s in?

Assuming Andy Burnham is crowned prime minister this week, the first important decision for businesses and the economy will be who he picks as chancellor. Not because we expect an emergency budget, but because his choice will strongly signal his economic priorities. Betting markets currently put Ed Miliband at 60%, which would suggest a focus on more tax, spending and investment. A pick like Wes Streeting would be more in line with sticking to the current fiscal plans.

More taxes, spending and borrowing: the options for raising more fiscal room

Whoever he picks as chancellor will face the same fiscal constraints as Rachel Reeves. Andy Burnham has committed to keeping the fiscal rules and sticking to Labour’s manifesto commitments not to raise income tax, national insurance or VAT.

As a result, Burnham and his new chancellor will face the same trilemma as Reeves and Starmer: how to satisfy ever-increasing demands for more spending, as well as a desire for a surge in investment in utilities and housing, without increasing the major taxes or breaching the fiscal rules.

The options:

• The ‘smorgasbord’ - the most obvious option is to revert to the ‘smorgasbord’ approach of increasing lots of smaller taxes, which in aggregate add up to a significant amount. The downside is that smaller taxes tend to have larger and more damaging side effects, and they are notoriously difficult to forecast, making borrowing overshoots more likely. That will inevitably mean a focus on wealth taxes, such as capital gains tax. We are likely to see a lot of speculation around this in the run-up to the next budget.
• Backloading tax increases – another likely option is to spend more now and backload tax increases into the next parliament. That is largely what Rachel Reeves did in the last budget, with the tax burden already set to rise to a post-war high. Markets were relatively sanguine about that, but another round of backloaded tax increases would stretch credibility to breaking point and probably result in higher borrowing costs, especially if accompanied by a substantial short-term boost to spending, which would push up inflation.

We will, of course, be writing much more on the likely tax options in the run-up to the next budget. For now, though, the direction is clear: up.

However, there is also room for a bit more borrowing while staying within the fiscal rules. Rachel Reeves increased her headroom against the fiscal rules to £23.6bn in the last budget and, while recent events mean a lot of that will have been eroded, Burnham could increase borrowing and push that headroom back towards the £10bn it had been for most of this parliament, maybe with the promise of increasing it again in the future. Of course, there is good reason that we, and plenty of others, criticised having such a tiny amount of headroom. As we have seen recently, geopolitics can easily wipe out such a small buffer, leaving tax policy at the mercy of events and leading to constant speculation about tax rises. That is not a smart place for any chancellor to be.

Regardless of the specific tax policies the new administration comes up with, there will inevitably be a huge amount of speculation ahead of the next budget. If the previous two budgets are anything to go by, that will cause significant disruption to economic activity. For example, if people fear capital gains tax going up, we may see a flurry of asset sales ahead of the next budget, while the prospect of new property taxes may put a dampener on the housing market. The risk is clear: budget speculation later this year could cause the economy to grind to a halt, just as it did in 2024 and 2025.

Devolution is not a short-term fix

The central pillar of Burnham’s proposition is devolution, which he broadly defines as the shifting of political and economic power out of Westminster. The rationale is obvious: there is significant regional inequality in the UK, and the UK is one of the most centralised economies in the Western world. By putting money in the hands of local leaders, rather than having it administered from Westminster, taxpayer money is more likely to be funnelled towards projects that benefit local economies. There is decent international evidence from countries such as the US and Switzerland to suggest that this can work. It is also politically popular.

However, this is easier said than done — remember ‘levelling up’? Even in a best-case scenario, it is likely to take years, or more likely decades, for devolution policies to have a noticeable impact on growth. For most businesses, there is unlikely to be much noticeable difference this decade.

Of course, devolution will only benefit regional economies if local governments use their new powers wisely. The most effective way to boost growth is to adopt the same ‘yes in my back yard’ (YIMBY) planning policies that have been successful in Manchester. However, that will likely require significant additional incentives from Westminster and take time to feed through.

One reason for the UK’s poor productivity has been the lack of long-term planning and investment, so efforts to improve that should be applauded. But these reforms are unlikely to boost trend growth before the next parliament.

Risks are weighted towards short-term ‘juicing’

The lengthy lags involved in seeing the payoffs from structural reform, coupled with the need for Burnham to show results before the next election, which must be held before August 2029, mean he will be heavily incentivised to do more to improve living standards over the next couple of years, especially in the context of a stagnant economy.

That raises the risk of ‘buy now, pay later’ fiscal policies, which stimulate growth now but require a bigger fiscal consolidation in the next parliament, or push interest rates even higher, making the eventual fiscal consolidation more painful.

But, for now, England getting to the World Cup Final may have a bigger impact on the economy this summer than anything that happens in Westminster.

GDP steady despite Iran shock

GDP was likely unchanged in May, but strong underlying momentum should continue to support Q2 growth.

Starting with industrial production, we expect a healthy 0.6% gain in May as utility demand surged, likely due to the heatwave driving up the use of air conditioning and fans. Mining output should also surge, based on the signal from North Sea loadings, but we see downside risk given how volatile mining activity can be and how strong activity was in April. Elsewhere, we see already elevated manufacturing output holding steady as firms continued to front-run potential supply shortages in May.

We expect construction activity to drop by 0.7%. Industry surveys remain dismal as sentiment continues to be dragged down by political and global uncertainty. What’s more, activity has risen for four straight months despite the signal from surveys, as our chart below shows, so some payback is likely.

Finally, services output will likely stagnate in May. The Services PMI fell a little below 50, consistent with a contraction in private sector services, so we expect some weakness from the usual stalwarts such as IT and professional services. New car sales will also drag on growth as consumers held off on major purchases because of the surge in uncertainty caused by the Iran war. That said, consumers have not completely cut back on spending. Retail sales jumped 1.2% in May, and the signal from our RSM-CGA hospitality tracker is consistent with a 0.7% m/m gain, suggesting continued, albeit subdued, consumer spending growth through Q2.

Elsewhere, healthcare output should rebound strongly after resident doctors’ strikes dragged on activity in April, which will mean the economy avoids a second consecutive month of contraction.

All told, growth has slowed sharply in recent months as the Iran war drags on activity. However, the economy had a lot of momentum coming into the spring, which means it should still grow by 0.2% across Q2. That will put the economy on course to grow by around 1% this year. That’s a bit slower than last year, but not necessarily a bad showing in the face of war and political turmoil.

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