UK bond vigilantes circle gilts as election losses hit PM Starmer

Early results from local council elections on Friday showed major losses for Britain’s ruling Labor Party, raising questions about Keir Starmer’s future as prime minister.

Voting numbers showed hundreds of Labor councilors losing their seats and many local council leaderships changing hands.

The predicted outcome will not affect the makeup of parliament at Westminster or who is in government, but it reflects negative sentiment among voters about Starmer’s leadership.

Labor and its main opposition party, the Conservatives, are expected to suffer heavy losses, while right-wing Reform England and the left-wing Green party are also expected to make big gains.

Backbench Labor MPs (MPs who do not hold a position in government) are reportedly planning to blame the impending losses on the prime minister and demand his resignation.

While Starmer and finance minister Rachel Reeves battle discontent within their own ranks over fiscal policy, welfare reforms and the appointment of Peter Mandelson, a business partner of late sex offender Jeffrey Epstein, as US ambassador have further damaged cross-party relations.

Health Secretary Wes Streeting, former Deputy Chancellor Angela Rayner and Manchester Mayor Andy Burnham are reportedly among the candidates to replace Starmer. Rayner and Burnham, who is currently ineligible for the post of prime minister because he does not have a seat in parliament, are generally considered more left-leaning than Starmer.

However, markets favor Starmer and Reeves maintaining their positions over potential alternatives; UK bonds have been selling off during previous periods of uncertainty about their political future.

Last July, yields on UK government bonds, known as gilts, rose amid reports that Reeves’ role in Starmer’s cabinet was in jeopardy after he was seen crying in parliament. This comes after the government turned down proposed welfare cuts following a rebellion by Labor politicians.

Comparative return 10 years U.K. government bonds, known as gilts, rose 1 basis point in early trading in London as investors awaited new election results. Earlier this week, these yields rose to their highest levels since 2008 following reports that a post-election coup was being planned against Starmer from within his own party.

Bond yields and prices move in opposite directions.

Gilt returns were mixed across the curve; While 2-year gilt yields were slightly higher, 20- and 30-year gilt yields were slightly lower. Long-term gold yields also rose to multi-year highs earlier this week, with 30-year borrowing costs reaching their highest level since 1998.

The UK already has the highest government borrowing costs in the G7, with 10, 20 and 30-year debt yields above the critical 5% threshold. Yields effectively represent the interest the government pays to investors who hold its debt.

Nigel Green, chief executive of financial consultancy deVere Group, told CNBC early Friday morning that gilt markets could become “one of the biggest political risks facing Keir Starmer and Rachel Reeves” after local elections.

“Labour has already lost around 58% of the council seats it defended in the overnight results. If losses continue at this pace, the party could face a loss of close to 1,500 seats overall,” he said in an email.

“Markets pay extremely close attention to political authority, especially when governments are already facing difficult financial conditions.”

Green said rising gold yields were a “serious warning sign” and that investors were demanding higher premiums to hold Britain’s debt.

“Markets are questioning whether Labor can maintain fiscal discipline, support growth and reassure investors at the same time,” he said.

“Rachel Reeves is fully committed to Starmer politically on the economy. If gilt yields remain under pressure as Labor absorbs heavy election losses, investors may begin to conclude that the government is both politically weakened and fiscally constrained.”

Green added that sterling has so far avoided a major sell-off, but currencies and bond markets often move together when confidence begins to deteriorate.

“If investors lose faith in the government’s ability to control borrowing or maintain economic credibility, pressure on sterling could intensify rapidly,” he told CNBC. “For Downing Street, this becomes dangerous when political weakness and market weakness begin to feed into each other.”

Jonathon Marchant, fund manager at UK-based Mattioli Woods, told CNBC that the first indication was that “it’s probably going to be a tough day for Kier Starmer.”

“Given the tensions that escalated overnight in the Middle East and its impact on oil and inflation, unraveling the market’s perception of local elections is challenging,” he said. “Gilt yields fell slightly at the open, with the market appearing to have priced in a marginally worse outcome for Labor ahead of the local election.”

Marchant said Starmer “has remained determined in recent weeks and will probably want to continue the fight.”

“We could actually see the pace of policy change initiatives increasing,” he told CNBC. “But the question for markets is ‘in which direction?’ “Moving further to the left would likely appease the reserves and thwart domestic dissent, and while this would be more positive than a leadership change, it is not something markets would welcome.”