LONDON: As UK Prime Minister Sir Keir Starmer slowly loses allies in government and fights for his survival, the escalating political drama is heaping fresh pressure onto a bond market already battered by the country’s deep-rooted fiscal and economic problems.
Yields on longer-dated gilts are at their highest in decades and above bonds of all Group-of-10 peers. The latest lurch higher came as Starmer faced increasing calls for his resignation after his party was trounced in local elections last week.
Investors are nervous that a new Labour leader would be more left-leaning and, crucially, could further loosen the fiscal rules that have restrained the current administration from spending more and adding even more to the debt pile.
In an unusual turn of events, the debt market may actually be working in Starmer’s favour.
The so-called bond vigilantes are often seen as the nemesis of UK governments, setting limits on fiscal largess and even helping to topple leaders, most notably Liz Truss in 2022.
Now, as yields push higher, that’s feeding through to households in the form of more expensive interest payments on mortgages and credit cards. Labour members may be reluctant to oust Starmer if they fear a dangerous spike in borrowing costs, giving voters more reasons to reject the party.
More broadly, the latest volatility is another episode in the tension between politicians’ desire to spend and the bond market’s repeated push-back.
Particularly since the turmoil surrounding Truss’s mini-budget, which sent the pound to a record low and gilt yields surging, the United Kingdom never feels that far from crisis.
Away from the daily fluctuations in asset prices, there appears to be an inexorable momentum toward another fiscal showdown at some point between the government and the market.
Politics is just one element in the mix for the bond market. With Britain’s debt ratio above 90% of gross domestic product and inflation on the rise, investors have plenty of reasons to treat UK assets with caution.
“The simple reality is that this latest pressure, in a now long line of political upheavals, merely adds to the view that no matter who is in power, no matter their political leaning, there does not appear to be a credible plan to restore the country’s finances,” said Matt Cairns, head of fixed income strategy at Rabobank.
“Gilts will remain under pressure, regardless of today’s outcome.”
The UK 30-year yield, which is more sensitive to political and fiscal risks than shorter maturities, climbed above 5.80% on Tuesday, a level not seen since 1998.
It closed at about 5.77%, while the sterling fell against the US dollar and the euro.
As the selloff pushes up borrowing costs, the government will have to spend even more. The 20 basis-point jump in the 10-year yield since Friday adds an estimated £2bil to the debt interest bill by the end of the decade, according to Bloomberg Economics.
This latest UK political crisis comes at a time when bond markets globally have been pummelled by the energy shock triggered by the war in the Middle East.
It’s particularly problematic for the United Kingdom, where inflation was already stickier than in other regions, pointing to interest rate hikes ahead.
That’s a u-turn from the cuts anticipated at the start of the year. Bank of England rate-setter Megan Greene said in recent days that the risks to inflation are “entirely on the upside”.
The current market swings are far from the extremes seen in the wake of the Truss mini-budget, but that event has reinforced the gilt market’s position as the United Kingdom’s fiscal police.
But for some investors, that undermines the case for buying gilts as it requires being able to stomach near constant political risk and the market volatility that it inevitably creates.
Starmer and his Chancellor of the Exchequer, Rachel Reeves, have defined their agenda by a commitment to self-imposed fiscal rules designed to reassure investors they won’t borrow too much.
That stance has curbed the government’s capacity to spend as generously on public services as many in the Labour Party would like, fuelling discontent among lawmakers and voters.
Even as the prime minister battled for his job on Tuesday, markets were attempting to parse the potential ramifications for gilts and other UK assets.
“The danger here, this is a tail risk, is that Starmer could be replaced by someone who is further to the left, that attempts to raise taxes and borrowing, add more regulation on to the economy and then worsen both the inflation and fiscal outlook,” said Kallum Pickering, Peel Hunt chief economist, on Bloomberg Television. “That’s what’s being priced in today.”
Among the likely Labour candidates, Health Secretary Wes Streeting is seen as one of the most market-friendly replacements.
Another, Angela Rayner, has attempted to reassure investors that the Labour Party will keep a tight grip on public finances.
But she previously led a cabinet revolt against Reeves’ plans to slash welfare spending.
Many are also expecting a challenge from the Mayor of Manchester Andy Burnham, who’s previously promised to increase borrowing and said that the country is “in hock to the bond markets”.
He’s currently favoured by betting markets to get the job, even though he would need to find a route to Parliament given he’s not a sitting MP.
“The problem at the moment for the market is the uncertainty. There are now clearly three camps fighting for control – Starmer, Burnham and Streeting,” said Daniel Loughney, head of fixed income at Mediolanum International Funds.
“The best case for gilts is Starmer stays, second best is early leadership challenge and Streeting winning and worst is Burnham. But Burnham is lowest probability at the moment.” — Bloomberg
