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Long-term UK borrowing costs soared to the highest level in almost three decades on Tuesday as fears about a change of Labour leadership triggered investor jitters and warnings of further bond market turmoil.
With investors worried about potential changes to Labour’s tax and spending plans, the yield – in effect the interest rate – on 30-year government bonds, or gilts hit a high on Tuesday of 5.81%, a rise of 14 basis points and the highest since 1998.
Neil Wilson, an investor strategist at Saxo Markets, said: “We could see a blowout in longer-dated gilts if this turns into a dogfight – political, fiscal and inflationary risks will rise. Markets tend to dislike a lack of certainty over who runs a government; the fiscal position is already fragile and likely to become worse should a left-leaning ticket prioritise spending, and that makes inflation stickier.”
Yields later fell back very slightly, after the prime minister told a cabinet meeting that he would not resign and that the process for a leadership challenge had not been triggered.
Cabinet ministers including Peter Kyle and Liz Kendall made supportive comments – although several more junior ministers, including Jess Phillips and Miatta Fahnbulleh, resigned throughout the day, calling on Starmer to quit.
The prime minister said: “The Labour party has a process for challenging a leader and that has not been triggered. The country expects us to get on with governing. That is what I am doing and what we must do as a cabinet.”
The morning’s bond market sell-off partly reversed, as it became clear that Starmer hopes to cling on in Downing Street. The benchmark 10-year yield on UK government bonds dropped back to below 5.1%, having hit 5.13% earlier in the day, while the 30-year yield dipped to 5.78%.
Higher yields, if sustained, can raise the cost of borrowing for the government, consumers and businesses. Yields on the bonds of most major economies have been rising this year because of the inflationary impact of the Middle East conflict – but the UK has been hit especially hard.
April LaRusse, the head of investment specialists at Insight Investment, warned that UK bonds had “decoupled” from those of other countries, and if that process continued, prices could fall further, pushing bond yields higher.
“Investor attention has shifted to domestic political risk, particularly the possibility that a change in leadership could loosen fiscal discipline,” she said. “In our view, any new leader would move quickly to reassure markets and dampen volatility. The risk is all about timing. A drawn‑out or uncertain transition, or even no change at all, keeps speculation alive, and neither outcome is market friendly.”
Two potential frontrunners to succeed Starmer, Angela Rayner and Andy Burnham, have hinted they would like to see higher public spending.
Mohit Kumar, the chief economist for Europe at Jefferies, said: “Any replacement would likely be left leaning and be negative for the long end of the curve and the currency.” He said he expected a widening between shorter- and longer-dated UK borrowing costs, and was betting against the pound. Sterling fell 0.7% against the dollar on Tuesday, to $1.352.
Gilt yields had already risen this week amid concerns over a jump in energy prices leading to higher inflation. Oil prices rose on Tuesday as talks to end the US-Israel war on Iran appeared fragile. Brent crude futures rose 2.7% to $106 a barrel, while US West Texas Intermediate gained 99 cents, or 1%, to $99.06 a barrel.
Donald Trump said on Monday the ceasefire with Iran was “on life support”, pointing to disagreements over several demands such as the cessation of hostilities on all fronts, the removal of a US naval blockade, the resumption of Iranian oil sales and compensation for war damage.
Tehran stressed its sovereignty over the strait of Hormuz, through which about a fifth of global oil and liquefied natural gas flows in normal times, and where hundreds of tankers and cargo ships remain trapped.
Suvro Sarkar, who leads the energy team at Australia’s DBS Bank, said: “Optimism regarding an imminent [peace] deal seems to be fading again and if we don’t see a deal by the end of May then upside risks for oil prices are definitely on the table.”
Kathleen Brooks, the research director at XTB, said: “There is an upward bias for bond yields anyway, and the UK yields are facing a double whammy of an energy price spike and a political crisis. The risk is that we get a bond market meltdown in the UK in the coming days.”
