A wipeout for the government in last week's local elections has increased the chances of us getting a new Prime Minister (PM) later this year. That may help labour in the polls, but it is more likely to hinder rather than help the economy. A more spendthrift government will push borrowing costs even higher and would probably depress sterling. Another round of tax and spend would undoubtably damage confidence just as it did at the previous two budgets. Ultimately, the fiscal constraints on the UK will remain the same regardless of who is in Downing Street, that will put a reality check on big spending plans sooner rather than later.

What next for Starmer?

Last week’s local election results were as bad as expected, with labour losing almost 1,500 seats in England and taking a heavy beating in Scotland and Wales. This has intensified calls for Prime Minister Starmer to step down or at least set out a transition plan. One MP, Catherine West, even went so far as to say she would stand for the leadership if Starmer doesn’t stand down. West doesn’t have the support for a serious challenge, but it highlights the depth of feeling against PM Starmer remaining. The odds of Kier Starmer departing this year have now jumped to 75%, the highest since bookies started offering odds.

For businesses and the economy, the immediate consequence is probably a shift to the political left and potentially more public spending as Starmer and Reeves try to appease potential challengers. A tangible shift to the left risks pushing gilt yields - the cost of government borrowing - even higher if there is even a hint of looser fiscal policy. Given the cost of borrowing in the UK is already the highest in the G7, that would be a costly shift. Additionally, the prospect of further tax rises would damage confidence, just as we saw in the previous two budgets, which would dampen investment and growth. We didn't learn a huge amount in Starmer's Monday morning speech, but West has now agreed to stand down from triggering a leadership election, offering a small reprieve.

One surprising development is that UK gilt yields have fallen by more than elsewhere since the election results, suggesting markets are less worried about political risk. This is probably because Andy Burnham has now overtaken Angela Raynor as the favourite to eventually succeed Starmer as PM. That adds another hurdle to a leadership challenge as Burnham would actually have to become an MP first. But crucially, he is also seen as more business friendly than Angela Raynor, having championed YIMBY (yes in my back yard) policies in Manchester.

Ultimately, though, it looks like the UK is in for a period of looser fiscal policy and a bigger, more interventionist state. That would almost certainly mean higher borrowing costs than otherwise and would be very unlikely to have a noticeable impact on the UK’s short or medium term growth rate.

Fiscal constraints aren’t party political

That’s because whoever comes to power next is going to be facing the same constraints as Starmer and Reeves. In the short-term, the war in Iran will do more to determine the economic outlook over the rest of the year than government policy. The collapse of the latest deal between the US and Iran to reopen the Straits of Hormuz has sent oil prices back above $100 per barrel (pb) this morning. That will push up inflation and drag on growth, making the UK’s fiscal challenge even more difficult.

In the medium-term, the fiscal constraints will be the same for any government. Rapidly rising spending pressures from an aging population, an urgent need to boost defence capabilities and surging debt interest payments are pressing up against the highest borrowing costs in twenty years and the biggest tax burden since WWII. A new team in Downing Street won’t do anything to change those fiscal realities.

The only way to solve the fiscal puzzle is to boost the UK growth rate, but many governments have promised that and failed. Remember Starmer promising “growth, growth, growth”? There’s little reason to think whoever replaces Starmer will be able to accomplish that mission any more effectively.

UK Economy surged in Q1, but won’t last

We expect the economy to eke out 0.1% growth in March despite the outbreak of the Iran conflict.

On the production side of the economy, we expect output to stagnate as weaker manufacturing activity drags on growth. The good news is that we expect manufacturing to rebound in April as surveys suggest that orders were brought forward in anticipation of higher prices and potential supply shortages due to the Iran conflict, although this will be a temporary boost. Mining output should offset much of that weakness as North Sea loadings jumped in March. That said, mining output rose strongly in February despite the signal from loadings being weak and mining activity can be erratic so there’s a risk that official mining output slumps again.

The dismal construction sector had started to stage a rebound in the first couple months of the year, but sentiment is still weak and brick deliveries, which are a near-term indicator of activity, fell again in February suggesting that output will fall by 0.6% even as the weather improved into March after a wet February.

For services, we think activity will rise by 0.1% driven by consumers who were relatively unbothered by the outbreak of the conflict in Iran. Indeed, motor trades output should surge based on the signal from new car registrations rising by 15.4%. What’s more, our RSM-CGA hospitality tracker showed the sector recovering from a weak start to 2026 with total sales growth rising to 4.3% from 2.9%.

All told, we think the economy will continue growing in March, but the risks are clearly skewed towards a much sharper slowdown in output. For Q1, that leaves growth at 0.6% q/q, but this momentum will fade in Q2 as higher energy prices start to drag on activity.

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