A rise in gilt yields, international investors aghast, political chaos. No, not the aftermath of former UK premier Liz Truss’s disastrous mini-budget in September 2022, but the very contemporary fallout from sitting Prime Minister Sir Keir Starmer’s slide from power.

Shattered confidence is being felt most immediately in the sovereign bond markets, with 10-year gilts topping 5% this afternoon (12 May) – the highest in the G7, despite having a lower debt-to-GDP ratio than all within that club but Germany.

But the market impact will run wider, including on equity and transformational M&A deals. The only question to grapple with is its magnitude.

Political instability “makes it harder to invest in the UK,” a veteran bulge-bracket banker despaired.

Downstream of the leadership question, Labour’s stewardship of the British economy is equally in the dock. “It’s almost as if they have no idea about economic policy at all,” one Magic Circle M&A partner said.

Investors cannot be comfortable dedicating substantial capital to UK-focused assets without a clear view of the operating environment in the next few years. Consequently, a lot of the fear surrounds what comes after Starmer.

This is critical to understand when modelling the consequences on deal pipelines.

It wasn’t meant to be like this. The 2024 election was sold as an end to the chaos that ensued as Brexit and covid convulsed the then-ruling Conservative party. Alas, Starmer’s Labour administration appears to be singing from the same discordant hymn sheet.

Following disastrous local authority, Scottish Parliament and Welsh Senedd elections last week, Starmer’s position as prime minister looks increasingly time limited.

If he is forced out of office this year, the UK would have jettisoned its sixth prime minister in the 10 years since voting to leave the European Union (EU) in 2016. The UK has gone through more heads of government than any other G7 nation in that same period. Even Italy, famed for political instability, has only had five.

Accumulated unforced errors from the UK’s major political parties are taking their toll. While the UK’s inflation is stickier than some other G7 nations, implying higher headline interest rates, that isn’t sufficient to explain the gap between the cost of UK debt and other large economies.

In the wake of the Truss debacle, economist Dario Perkins coined the term “moron premium” as an explanation for the spread between UK sovereign yields and others in ostensibly similar fiscal shape.

That premium is a reasonable proxy for concerns shared by market participants and dealmakers.

“It would be too strong to say the UK is completely un-investable, but this is far from helpful,” said another UK-based banker. “Starmer is correct that this instability impacts the economy and international investor view of the UK, as you can see from the yields.”

“One of the key roles of central government, which seems to be completely forgotten about now, is to promote confidence in a country through stability. This isn’t happening and the market fears that the next option is far, far worse.”

We know what investors would think of a company exploring the possibility of its seventh CEO in 10 years.

Labour has had a record of paying lip-service to being business and investment friendly since entering government but has often harmed this perception by flirting with populist polices deemed unfriendly to investment, like wealth taxes.

More concretely, Labour’s own budgets and fiscal policies have also been a thorn in its supposedly pro-growth business-friendly agenda.

“There’s been an anti-growth tilt in tax policy,” according to Kallum Pickering, Chief Economist at Peel Hunt.

There is little doubt that Labour received a poor fiscal inheritance from the Conservatives, but “raising taxes on profitable parts of the economy stalls the process where profits are recycled,” Pickering argued. Labour has faced considerable criticism for raising businesses’ national insurance contributions and hiking the minimum wage.

Adding political chaos into the mix dampens the UK’s hopes of reviving its IPO market, encouraging pension investment in domestic industry, and persuading innovative British businesses to from and grow in their home market.

“If you were starting a business now, there is very little reason at the moment to stay here,” added the second banker.

You wouldn’t blame the CEO of a new Oxford- or Cambridge-based technology start-up from jumping on the first plane they could to California for US venture capital on the eventual path to a Nasdaq listing, perhaps with a layover in Delaware to settle their company’s incorporation.

Thankfully, this banker noted there was little imminent deal flow in the UK IPO pipe to be impacted by the fight for Number 10. Driving services business RAC has kicked its listing to the second half of the year due to market volatility, fintech firm SumUp Payments is in the process of hiring advisors, and Waterstones is not expected to be brought to market until at least 2H.

Another banker noted, however, that further political disruption was likely to narrow the viable UK IPO market to a select group of large-cap businesses and very high-quality growth companies rather than support the broad-based economic recovery required which would lead to more UK listings.

The longer the turmoil continues, the easier it will be for equity investors to spurn UK listings and domestic-focused takeovers.

Indeed, Chancellor of the Exchequer Rachel Reeves’ first tax raising Budget in Autumn 2024 created a chilling effect across UK M&A that stretched into the spring of 2025.

Sellers and advisors running the rule on consumer-facing and operationally UK-heavy deal situations such as bakery chain Gail’s, baker Jason’s Sourdough and L’Occitane-owned UK skincare player Elemis will be hoping drama in Westminster doesn’t further complicate bid/ask headaches affecting mid-market transactions both sides of the pond.

A way forward

Yet a word of caution amid the chaos is always helpful.

The more UK-focused FTSE 250 index may be down more than 1% this afternoon, but the blue-chip FTSE 100 – whose constituents derive some 75% of their profits overseas – is down only a modest 0.38%.

UK-domiciled businesses with a hefty overseas footprint are largely immune from the crisis. The Magic Circle lawyer saw “no impact on deal sentiment” in this bracket, adding there are “tasty UK morsels” in the pipeline.

Indeed, there is “too much muscle memory from 2022”, Pickering said, with market observers keen to draw the Truss parallel but not doing so with sufficient caution. Truss cut taxes during an inflationary spiral, he noted. While dismissive of Labour’s economic stewardship, Pickering did not see leadership candidates such as Greater Manchester Mayor Andy Burnham, Health Secretary Wes Streeting, or Energy Secretary Ed Miliband making similar errors.

One possible outcome is markets price for a bad outcome and then realise whoever emerges is not so inflationary, Pickering said.

The key risk – whether under a miraculous Starmer revival or, more likely, a new prime minister – is more weighted towards tax rises.

Any Labour leader will need to be bolder on policy. The UK needs structural change.

With borrowing limited by fiscal constraints, any generational investment in energy and defence will need to be backed by further tax rises. Voters want tax cuts, Pickering said. But if Labour decides levy hikes are necessary and focus on manifesto-busting income tax rises, proceeds would need to be focused on capital spending rather than current expenditure to plausibly boost supply potential, he argued.

Such tax rises would also have to be accompanied by spending cuts, particularly on welfare, which might be politically unpalatable to the Labour party, to have any chance of a reasonable reception in the City of London.

“The chaos makes it harder to invest in the UK,” said another UK investment banker. “There is a case to raise taxes but if they raise taxes they need to cut spending – they can’t keep loading taxes on people who are working to pay for people who aren’t.”

Putting aside any debate about the generosity of the UK’s welfare state, it’s a settled view among City dealmakers that Labour would need to make strides to rein in spending if it wants to take taxes higher.

Economic growth would certainly make these decisions easier – and that remains elusive.

It is no coincidence that the vote to leave the EU represented an inflection point, at which the UK transformed from a stable democracy into a country that gets rid of its leaders at a pace that would seem ruthless even for a Premier League football club.

Starmer has already indicated he intends to make further EU alignment a key plank of his economic reset. But he needs to be bolder. His touted youth mobility schemes are all well and good, but the imperative should be to return the UK to the bloc’s economic core.

“Starmer is right on the need to be far closer to Europe,” said the second banker, pointing to a decade of bleeding confidence and investment since the 2016 referendum.

The UK is primarily a London-centric services exporter that is still mostly cut off from its largest historic market across key industries.

If Starmer, or whoever replaces him, can chart a course towards a meaningfully closer EU relationship, they may finally narrow the “moron premium”.

Only boldness will do. Anything less will entrench the view that the UK is en route to tanking its investment status.