To stay in the top job, a British prime minister has to try and keep certain groups happy. MPs, party members and donors do not like to be ignored.
Nor do the bond markets. And often it feels like they matter the most.
That’s because those markets are what make it possible for governments to spend money. Each of the bonds is essentially a loan from an investor to the state.
In return for the loan, the government pays a certain amount of interest (yield) for a set period, before paying back the original amount.
Governments seen as safe and financially credible can usually borrow at cheaper rates. But if investors become worried about inflation, or excessive borrowing, or weak economic policies or political instability, they might demand higher yields to compensate for the greater risk.
It’s the same principle that applies to ordinary household borrowing. A person with a stable income and a good credit history can borrow more cheaply than someone seen as a financial risk.
Modern governments rely heavily on borrowing to fund public spending on everything from schools to hospitals and defence. This is why they pay such close attention to market confidence.
Within that market are a wide range of investors, including pension funds, banks and insurance companies. Together, their investment decisions determine how expensive it is for governments to borrow money.
If those investors do become worried about a country’s economic management, the government’s borrowing costs go up, leaving less money available for public services, infrastructure, tax cuts or welfare.
The name’s bond
In the UK, total government debt now stands at about £2.9 trillion with interest rates (yields) currently higher than those paid by the US, Italy, France, Canada, Germany and Japan.
Every 1% point rise in yields costs the UK government an extra £16 billion a year in debt interest payments.
And while bond markets may sound technical and distant, their movements can influence everyday household spending. When the interest charged on UK bonds rises, for example, British banks face higher funding costs themselves. This then feeds into higher mortgage rates, more expensive business loans and tighter financial conditions.
Bond markets also affect pensions because pension funds invest heavily in government bonds. Sudden rises in yields can create financial stress for pension funds and affect the value of pension savings.
Taxation is affected too. When governments must spend more money on debt interest payments, they will often have less room to cut taxes or increase spending on public services. In some cases, governments may even need to raise taxes or reduce spending elsewhere to keep public finances under control.
Powerful bonds
A political adviser to the former US president Bill Clinton once joked that he would like to be reincarnated as the bond market because it could “intimidate everybody”.
But if elected governments are constantly worried about what bond markets think, does this limit democratic choice?
Some critics argue that governments have become overly constrained by financial markets and excessively cautious about borrowing and public investment. They question why unelected investors should have so much influence over public policy.
Others respond by saying that bond markets act as an important nudge towards economic stability. Investors are lending real money and naturally want reassurance that governments can manage debt responsibly.
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This debate is frequently mentioned in British politics. Comments by Andy Burnham, widely seen as a potential future prime ministerial candidate, that governments had become “in hock to the bond markets” quickly raised questions about how financial markets might react to his economic approach. He later softened his comments in an apparent attempt to avoid unsettling investors.
And the reason why politicians are so careful about unsettling bond markets became painfully clear during the brief premiership of Liz Truss in 2022. When her government announced large unfunded tax cuts, investors were instantly worried about higher borrowing and the lack of a credible fiscal plan.
Bond yields surged sharply and mortgage rates increased as banks and lenders raised borrowing costs. Political pressure on the government quickly became overwhelming. And Liz Truss resigned after just 45 days in office.
None of this means bond markets run the country. Governments still make political and economic decisions. But governments that lose investor confidence can find those decisions becoming much more difficult and expensive to finance.
It also doesn’t mean that markets always get things right. Investors can overreact, panic or misjudge economic conditions. But governments cannot ignore borrowing realities indefinitely, particularly when debt levels are high and inflation remains a concern.
For much of the decade following the global financial crisis of 2007, ultra-low interest rates reduced pressure on governments. Borrowing was relatively cheap and bond markets became less politically visible.
But that changed from 2023. Higher inflation, rising interest rates and elevated public debt have pushed bond markets back to the centre of political debate across many countries.
This helps to explain why discussions about fiscal credibility increasingly dominate modern politics. Bond markets do not decide elections or choose prime ministers. But they can strongly influence what governments feel able to do once elected. And that is why politicians, regardless of ideology, continue to watch them so closely.
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