City economists and analysts are concerned that UK government borrowing costs could rise if the Labour Party holds a leadership race this summer. UK bond yields could be pushed higher if investors fear an increase in borrowing under a Burnham administration, as the new MP for Makerfield pledges to address the cost of living crisis.
Market Reactions to Political Uncertainty
Dan Coatsworth, head of markets at AJ Bell, says there is potential for gilt yields to keep rising if Starmer “doesn’t go quietly.” With 10 and 30-year bond yields higher today (in line with other European government bonds), Coatsworth notes: “Friday’s moves reflect the risk that Starmer won’t go quietly. But they also reflect the setback with the US-Iran peace deal which has caused oil prices to rise again today, and inflation fears to remain on the table, thus having a direct read-across to interest rates and bond yields.”
He adds: “Over the coming days, the bond market will look for clues on Burnham’s chances for getting the top job, and how he might steer Labour in a different direction. He might not have wanted to rock the boat ahead of the by-election for fear of causing upset or ruining his chances. Now he’s in a stronger position to lay out policy changes and not simply tow the party line.”
Bond Yield Trends
Bond yields rise when the price of the bond falls, and are a gauge of the cost of issuing new debt. This morning, the yield (or interest rate) on UK 30-year bonds is up 8 basis points (0.08 of a percentage point) to 5.529%. That’s only the highest since Tuesday, and some way below the 27-year high of 5.89% set in May, when borrowing costs were climbing.
Alexandros Xenofontos and Christopher Granville at City firm TS Lombard say gilts (UK government bonds) are constrained by the return of domestic political risk, explaining: “The question for gilts is whether the next Labour leadership preserves the Starmer-Reeves fiscal bastion, shifts left through funded tax-and-spend, or starts testing the fiscal rules.”
Investor Concerns
Neil Wilson, investor strategist at Saxo UK, sees signs that markets are already worrying about the result from Makerfield, because: “a) the uncertainty that naturally surrounds a leadership race and b) more importantly, a likely crowning of Burnham as PM and leftwards lurch by the government as he is widely seen as the least market friendly option. I wouldn’t be surprised if the multi-year/decade highs on the 10yr and 30yr are not tested again as he sets out his policy ideals.”
He continues: “That said, however, the macro backdrop is different to early May when market angst over inflation was elevated and the market was pricing in multiple rate hikes by the BoE. The calculation relating to Hormuz and the BoE has changed markedly since then but the market will be hyper sensitive to how Burnham runs his campaign now. There’s also the scenario in which Burnham replaces Starmer, and calls a snap general election, to consider.”
Potential Snap Election Risks
AJ Bell’s Dan Coatsworth says that could really worry the bond market: “Should an early general election be called and were Labour to lose power to Reform, then bond markets could have a much bigger issue on their hands. A Reform government would almost certainly make investors demand a higher reward for the risk of backing the UK, as Reform’s policies are currently thin on detail. In that situation, expect higher bond yields, a more volatile pound, and concerns that any unfunded tax cuts will put even more pressure on government borrowing.”
