What impact can political changes have on UK investment returns?

By Joe Aylott, Multi-Asset Strategist, Coutts

• Political changes may cause short-term volatility in financial markets; however, over the long term, political factors have less impact on the performance of UK assets than global economic conditions. 
• We are global investors and believe that exposure to global financial markets is the best starting point for helping our clients achieve their financial goals.
• We remain underweight global government bonds, including UK gilts, due to their current, diminished diversification characteristics, coupled with inflation that remains above central bank targets and is proving sticky. 

Over the long term, political change tends to have less of an impact on the performance of UK assets than you might imagine.

FTSE 100 returns have been variable across different prime ministers, but this is largely due to the global economic environment rather than domestic government policies. 

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

If we see a change in UK leadership, the greatest impact is likely to be seen in the government bond and currency markets, which more directly reflect UK domestic economic growth and spending. However, the UK’s global peers have also experienced a rise in borrowing costs, albeit at a lower rate, due to global market concerns about debt sustainability.

The potential impact of changing leadership dynamics

The UK’s debt-to-GDP ratio is above 100%, and inflation is above the Bank of England’s (BoE) 2% target. This means the UK’s fiscal and monetary policy will likely remain relatively tight, irrespective of political leadership. However, UK government debt as a percentage of GDP is 20 percentage points lower than the G7 average and lower than that of all G7 countries except Germany. 

Money’s too tight to mention

The UK has experienced higher, and more volatile, inflation than its peers in recent years. This has led to an increase in the ‘term premium’ on UK debt – the compensation investors expect for committing capital to long term government bonds.

There are several reasons for this, including the UK’s reliance on energy and food imports, as well as currency volatility, which can feed through into inflation. This makes the UK – and its bond yields – particularly sensitive to the Middle East conflict, and any extension to hostilities and energy disruption.

From a structural perspective, a unique challenge facing the UK is that it has a significantly higher proportion of inflation-linked government debt compared to its peers. Twenty-five per cent of UK government debt is inflation-linked, compared with 9% in the US and an even lower percentage in Germany. This has resulted in higher and more volatile debt servicing costs.

Given demographic pressures, government debt trajectories are unlikely to change meaningfully in the near term. This raises the possibility of further upward pressure on yields, which could introduce periodic volatility into government bond markets.

Interest rate hikes expected

The conflict in the Middle East, along with its inflationary consequences, has led financial markets to price in three rate hikes by the BoE.

Given weakness in the UK labour market, we do not expect the BoE to implement all the rate hikes currently anticipated by the market. If fewer than three rate rises materialise, this would alleviate some of the pressure on gilt markets. Nonetheless, given accelerating economic growth in parts of the global economy and persistently elevated inflation, we remain comfortable maintaining an underweight position in bonds.

How are we positioned?

While the health and success of the UK economy remain important, their impact on our investment holdings is relatively limited. We maintain a global investment perspective and currently hold a neutral stance on UK equities. Within our UK equity exposure, we prefer domestically focused segments demonstrating stronger earnings momentum.

We remain underweight in global government bonds, including UK gilts.

Since January 2025, we have maintained an overweight position in sterling. Given sterling’s significant valuation discount relative to the US dollar, we remain comfortable favouring it despite potential short-term pressures stemming from political developments.

Avoid the noise, focus on the fundamentals

Political developments are influencing some short-term financial market movements; however, our approach remains guided by longer-term economic fundamentals. Whether politically driven or not, we recognise that periods of market volatility are inevitable. Consequently, our portfolios and funds are constructed with this in mind. Our positioning is determined by underlying economic fundamentals rather than by short-term political shifts.