(May 15): UK government bonds tumbled after Manchester Mayor Andy Burnham secured a pathway to potentially challenge Keir Starmer for the prime minister’s job, threatening a fresh bout of political instability that investors fear could result in more expansive fiscal policy.
The yield on 10-year gilts jumped 15 basis points to 5.14%, the highest since 2008, with global concerns about high energy costs and inflation also driving the move. Burnham’s announcement that he intends to run for Parliament — a prerequisite to challenge Starmer — put the pound on track for its worst week since 2024 against the dollar.
While there are plenty of hurdles to overcome, the prospect of Burnham becoming the prime minister is seen as a risk by UK bond traders, who fear he might increase public spending and with it gilt issuance.
Although Burnham said that his remarks last year about the country being “in hock” to bond markets were taken out of context, it nonetheless spooked investors. He has suggested there could be an exception for defence spending that would sidestep the government’s fiscal rules.
“The market’s fear is that Burnham would be more left-leaning, and we could see further increase in deficits,” said Mohit Kumar, a strategist at Jefferies. “Our base case is one of a manged exit for Starmer and Burnham likely becoming the next PM. We keep our steepening bias on the curve and an underweight for the currency.”
See also: Starmer rivals prepare to challenge weakened UK PM
The UK’s national debt has swelled sharply since the pandemic and is now at its highest relative to the size of the economy since the 1960s.
A sweeping defeat for Starmer’s Labour Party to populists Reform UK in local elections last week deepened concerns about his unpopularity with voters and triggered the current crisis. Starmer and his Chancellor of the Exchequer Rachel Reeves are viewed by bond investors as more committed to keeping borrowing in check than their potential replacements.
Markets are particularly sensitive to the government’s debt sales after former prime minister Liz Truss’ unfunded spending plans sparked an exodus from gilts in 2022.
See also: UK economy posts best growth in a year as headwinds build
Global challenges
The latest political uncertainty comes against a challenging backdrop as bonds fell globally on Friday amid concern about surging energy prices due to the Middle East war.
Benchmark UK yields have risen by almost a percentage point since the US and Israel’s attacks on Iran, while traders have flipped pricing for Bank of England monetary policy from interest-rate cuts to hikes as inflationary fears mount.
Investors suggested gilts will need to fall further before they will buy in.
Thirty-year yields rising above 6% from around 5.80% now would look attractive, according to Lauren van Biljon, a senior portfolio manager at Allspring Global Investments, and Paul Skinner, an investment director at Wellington Management. Lloyd Harris, the head of fixed income at Premier Miton, said 10-year yields at 5.30% would start to appeal.
The pound was 0.3% lower against the dollar at 1.3358 and steady against the euro at 0.8708 at 11.07am in London on Friday.
Protracted contest
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Burnham’s announcement raises the stakes: the Manchester mayor is the only senior UK politician to hold a net positive approval rating among voters, according to YouGov, and is the preferred candidate for many on the left of the Labour Party.
A potential leadership contest could be protracted, with Burnham first having to succeed in a by-election that Nigel Farage’s Reform has vowed to win.
While they have yet to formally announce a bid, other possible contenders include former deputy prime minister Angela Rayner and Wes Streeting, who slammed Starmer’s administration in his letter resigning from the post of health secretary this week.
Burnham’s various comments regarding fiscal policy over the last year have attracted market attention.
Following his “in hock” remarks, he said in April that Labour’s budget constraints “will stay in any context”, while suggesting there could be an exception for defence spending. His argument, he says, is not that Britain can ignore markets, but that tax-and-spending decisions shouldn’t be whipsawed by short-term factors.
“The gilt market reaction is to be expected, but once again the gilt market is scared of its own shadow,” said Craig Inches, the head of rates and cash at Royal London Asset Management Ltd.
“Burnham will need to be very gilt market-friendly in his comments otherwise the UK headroom will have disappeared before he gets to No 10.”
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