The UK's long-term government borrowing costs surged to their highest point in nearly three decades on Tuesday. The influential British bond market is preparing for potential repercussions from local elections that could significantly impact Prime Minister Keir Starmer's political future.
Elections for over 4,800 local council seats will be held across the UK this Thursday. The ruling Labour Party is anticipated to lose as many as 2,000 seats, a result that would deal a heavy blow to the already fragile Starmer administration. Votes are expected to shift to the right-wing Reform UK party and the left-wing Green Party.
Reports suggesting that multiple Labour MPs are planning to pressure Starmer to resign voluntarily or set a departure timetable triggered a sharp rise in UK government bond, or gilt, yields on Tuesday. Backbench MPs reportedly intend to blame the Prime Minister personally for the anticipated poor performance in the local elections.
As of 1:45 PM London time, the yield on the benchmark 10-year UK government bond had increased by 12 basis points to 5.082%, its highest level since 2008. The 30-year bond yield rose by approximately 11 basis points to around 5.76%, reaching a peak not seen since 1998. Meanwhile, the 20-year bond yield also surged by about 14 basis points, hitting a 28-year high.
Prime Minister Starmer and Chancellor Rachel Reeves are already facing discontent within their party over issues including fiscal policy, welfare reforms, and the appointment of Peter Mandelson as ambassador to the US, given his past association with the late sex offender Jeffrey Epstein.
Health Secretary Wes Streeting, former deputy leader Angela Rayner, and Greater Manchester Mayor Andy Burnham are widely seen as potential successors to Starmer. Rayner and Burnham are considered to be to the left of Starmer politically; however, Burnham is currently ineligible to run for Prime Minister as he does not hold a seat in Parliament.
The bond market is unlikely to ignore a significant Labour defeat in the local elections, according to Nigel Green, CEO of deVere Group. He stated via email that investors would interpret the election results as a signal regarding leadership stability and fiscal discipline, not merely as a political event. Green highlighted that the market would closely watch the impact of the results on Chancellor Reeves's political standing, noting that she has been viewed as a key anchor for UK economic credibility. Any perceived weakening of her authority or a potential shift towards looser fiscal spending under political pressure could push gilt yields even higher, particularly affecting longer-dated bonds due to supply risks, with the 10- to 30-year segment facing the most pressure as investors demand a higher term premium.
Last July, UK gilt yields spiked dramatically after the government, facing a Labour rebellion, overturned Reeves's proposed welfare cuts. Subsequently, reports emerged questioning her position in the cabinet, and Reeves was photographed in tears in Parliament.
Currently, UK government borrowing costs are the highest among the G7 nations, with yields on 10-, 20-, and 30-year bonds all surpassing the key 5% threshold.
Green warned that in the current macroeconomic environment, the UK has little room for error. He pointed to weak economic growth, high government debt, and persistent energy-related inflationary pressures, suggesting that even a minor loss of credibility could trigger immediate market repricing. Investors would quickly factor in the possibility of looser fiscal policy, such as tax cuts for electoral purposes, increased spending pledges, or relaxed fiscal rules, leading to an immediate adjustment in bond yields.
The bond market crisis of 2022, triggered by former Prime Minister Liz Truss's unfunded "mini-budget" of significant tax cuts, remains fresh in the memory of gilt investors. The resulting bond market turmoil severely impacted pension funds and caused mortgage rates to skyrocket, leading to Truss's resignation after just 44 days in office. Green noted that a shock on the scale of the mini-budget is not necessary to unsettle markets again; a shift in market expectations alone could be sufficient.
Political uncertainty is already negatively impacting UK gilt performance, according to Nicolò Bragazza, Deputy Portfolio Manager at Morningstar Wealth. He stated that such uncertainty has become a constant feature for the UK gilt market, directly pushing up risk premiums, particularly at the long end of the yield curve. Should the elections further destabilize the government, both UK gilts and the British pound would likely face downward pressure. Bragazza advised investors to look beyond short-term noise and avoid overbetting on the political outcomes of the election, instead focusing on long-term fundamentals. He suggested that from a historical perspective, current gilt yields are attractive, some political uncertainty is already priced in, and the Bank of England maintains a prudent policy focused on containing inflationary pressures. While monitoring political developments and Middle East geopolitical risks, he maintains a positive long-term view on UK gilts.
Chris Iggo, Chief Investment Officer for Core Investments at AXA Investment Managers, pointed out that the frequent changes in UK prime ministers in recent years have significantly damaged sentiment in the bond market. Starmer is the UK's fifth prime minister in the past decade. Iggo commented last week that a lack of political stability and the absence of a long-term strategic fiscal outlook are harming confidence in the UK gilt market. While he finds UK gilt yields attractive, he described the associated market volatility as "uncomfortably high."