Politics batter the UK bond market once more, as Starmer remains under pressure

UK asset prices are under pressure today and UK Gilts are clear underperformers as the prime minister loses allies and support from his own party, in the aftermath of the Peter Mandelson scandal. A political risk premium is once again being built up in UK asset prices, as the market fears what a new leader could bring to the table in terms of economic policy.

For now, Kier Starmer is still our Prime Minister, but this may not be the case in  the coming hours. It’s been a rough 24 hours for the PM, first he lost two close members of his team, then the leader of the Labour Party in Scotland held a press conference asking Starmer to stand down, ahead of critical local elections in May.

Scotland’s Labour leader may not be enough to push Starmer out of Downing Street, but if there are other heavy hitters, for example, cabinet ministers, who resign or call for Starmer to go, then the writing is on the wall for the PM.

UK bond market reacts to political turmoil

UK bond yields are underperforming across the curve, but the political risks are hitting the long end of the UK Gilt curve the hardest. The 10-year yield is higher by 6bps today, and the 30-year yield is at uts highest level since November last year at 5.4%.

UK becomes less governable than Italy

This is worrying for the Chancellor, as she tries to protect her hard-won fiscal headroom. Today’s move in the bond market suggests that it is unlikely to tolerate more political strife in the UK. If Starmer is replaced, then this would be the fifth prime minister for the UK since 2020. To put that into context, Italy has had two PMS, and the current PM Maloni appears to be secure in her position. The UK has become one of the weakest political links in Europe, and this will arouse the suspicion of bond vigilantes.

The pound is also one of the weakest currencies in the G10 FX space today, however, GBP/USD is managing to eke out a gain, as the dollar weakens. UK stocks are also underperforming, as UK assets get the cold shoulder from investors at the start of this week.

Bond market is one to watch, even if Starmer holds on to power

The bond market is the one to watch in the coming days, as the next 24 hours is critical for Starmer’s survival. If the PM does manage to hang on to power, then UK yields could fall back slightly, but we still think that it will be hard for the PM to assert his authority over the left wing of his party who are in favour of tax and spend policies. This could leave bond investors on edge, and UK yields vulnerable to bouts of selling pressure as we lead up to May’s local elections.

If Starmer does resign, then bonds could come under more pressure, as the market assesses the potential for a higher debt burden under each of the contenders for leader. This could also weigh on the pound in a more acute way.

Japan vs. UK

The contrast between Japan and the UK is stark at the start of this week. Japan voted in PM Takaichi with a super majority over the weekend, and her pro-growth policies have been welcomed with a fresh record high for the Nikkei. The UK’s political situation, in contrast, is market negative.

Can the UK learn from Japan? Pro-growth policies can win elections and boost asset prices, which has an ameliorating effect on business and consumer confidence.  

Chart 1: UK 30-year yield starts to rise once more

Source: XTB and Bloomberg