UK bond yields have been rising as investors panic about the 7 May elections.
- The market is concerned that the local elections will be an unrecoverable disaster for Keir Starmer
- UK government bonds were not starting from a good place
- A real challenge to Starmer’s leadership looks less likely than the market is pricing in
UK bond markets are increasingly nervous about the local elections. This week saw the 30-year gilt yield tip over 5.7%, levels not seen in more than 20 years. 10-year gilts are flirting with the 5% level, the highest level since before the financial crisis. Is this anxiety justified?
The worry appears to be that the local elections will be an unrecoverable disaster for Keir Starmer. He will face a leadership challenge, or be forced to resign, ushering in a left-leaning replacement such as Angela Raynor. Reeves will be replaced as Chancellor by someone with less fiscal prudence. Taxes will go up, spending will go up, economic growth will sink, there will be a bond crisis and so on.
It’s not as if UK government bonds were starting from a good place. The UK economy is particularly vulnerable to rising gas prices, and there was already real nervousness about the impact of the Iran war on inflation. The Bank of England governor did not help matters by issuing a hawkish statement on rates in the early stages of the war. James Flintoft, head of investment solutions at AJ Bell, says after the recent interest rate announcement: “the Bank has held, but the credibility cost of march is still being paid for in the gilt market every day. The MPC opened the door to an April hike last month, the market sprinted through it, and the governor has spent the last fortnight trying to close it again.”
All of this is bad. However, the pessimism doesn’t totally add up. A real challenge to Starmer’s leadership looks less likely than the market is pricing in – the only well-supported challenger (Andy Burnham) does not have a seat in parliament, with neither Angela Raynor nor Wes Streeting likely to command a combination of the PLP, the labour membership and the trade unions. Starmer can probably limp on, much as he is at the moment, and Reeves will have a good case that she is the only woman for the job.
Even if the Prime Minister is replaced, the new incumbent will ultimately come up against the immovable bond market maths. The UK has too much debt to spend more, and any leader is still tied to Labour’s election manifesto that promises no rises to corporation tax, income tax or national insurance. The ‘back-of-the-sofa’ tax rises have probably been exhausted. If economic growth sinks, that would make a case for cutting rather than raising interest rates.
The war in Iran remains a wild card, but the rise in gilt yields may be overdone. Volatility may deter investors in the short term, but there may be better news in the long term.
