Jitters coursed through UK bond markets on Wednesday after a leadership crisis engulfing the Labour government triggered a jump in gilt yields, leading investors to warn that more political instability risked exacerbating the ‘moron premium’ applied to UK borrowing costs.
Interest on 10-year gilts rose by three basis points, while the pound slumped to its lowest level against the euro in over two years, as rumours of a leadership challenge and a string of anonymous briefings fuelled speculation over the long-term future of Keir Starmer’s premiership.
The fresh crisis, which comes just a fortnight before the Chancellor’s crucial Autumn Budget, began on Tuesday night when a No. 10 official accused health secretary Wes Streeting of plotting against the Prime Minister. In an extraordinary set of comments that sought to preempt a leadership challenge from Streeting and other Labour ministers, Downing Street aides branded an attempt to oust Starmer as “reckless”.
They added that any new leadership would also trigger a rout in government bonds and worsen the UK’s already moribund public finances.
The comments sent shockwaves through Westminster and the City. Several bond investors warned that a protracted bout of political instability risked exacerbating the premium already placed on borrowing costs for the country’s fiscal excess.
Bond traders shaken and stirred
“It may seem desperate to tie his survival to market sentiment, but the instinct isn’t wrong,” James Carter, fixed income portfolio manager at W1M told City AM. “Bond yields would not take kindly to renewed political instability. The [UK] gilt market, like it or not, remains the whipping boy of global bond markets – a force not to be underestimated, as Liz Truss discovered.”
Rachel Reeves has repeatedly sought to reassure nervous bond markets over her attempts to keep a lid on the budget deficit in the run-up to a momentous Budget on 26 November despite persistent pressure from some corners of the Labour party. In a highly unusual ‘Scene Setter’ speech last week, she reaffirmed her “ironclad” commitment to the government’s fiscal rules, which compel it to match day-to-day spending with revenues by 2030.
Michael Brown, a senior research strategist at Pepperstone, told City AM the Chancellor’s rhetoric has meant gilt investors take a “better the devil you know” approach to Starmer’s government, despite its well-documented struggles to kickstart sustained growth and tighten spending.
“I don’t think any gilt market participant is sat there thinking Rachel Reeves is a dream Chancellor,” he said. “But she and Starmer together are… all that is stopping us from having someone massively on the left of the Labour party who doesn’t think of fiscal rules with such a deity-like view.”
Market highly sensitive
Richard Carter, fixed income analyst at Quilter Cheviot, added: “I think the gilt market is very sensitive to any UK political uncertainty ahead of the Budget, although the market has been doing quite well of late due to rising hopes of Bank of England rate cuts.
“Rachel Reeves has also done a good job – so far – of persuading investors she is committed to fiscal discipline.”
The UK’s long-term bonds have traded at a premium to those issued by many other developed countries ever since the 2022 mini-budget set off turmoil in the gilt market. The interest on 10-year gilts is currently 30 basis points higher than their American equivalent despite the US’s larger deficit.
“[More leadership speculation] is not a great look, and it’s not doing anyone any favours in terms of ensuring that international investors have confidence in the stewardship of the UK economy,” Brown added.
The leadership speculation forced Streeting to deny plotting against the Prime Minister. And at an awkward Prime Minister’s Questions, Keir Starmer disavowed the comments that emerged from his own Number 10 operation, saying any briefings against ministers were “unacceptable”.
“[Streeting] is doing a great job, as is the whole of my Cabinet,” he told MPs.