U.K. Political Uncertainty Continues to Weigh on Gilts, Sterling

By Miriam Mukuru and Renae Dyer

U.K. government bond yields rose and sterling fell Monday in the wake of the ruling Labour Party's bruising defeat in local elections last week that raised questions over Prime Minister Keir Starmer's future.

Starmer said in a speech Monday that he had no plans to resign and vowed to step up efforts to meet the challenges facing the U.K. He said the government needs to make a bigger response than anticipated on growth, defense, relations with Europe, and energy.

"I know I have my doubters and I know I need to prove them wrong and I will," he said.

Gilt yields stayed higher and sterling remained lower after the speech. Some analysts have said that an immediate leadership challenge is unlikely, but that the prospect of monthslong political turmoil could hurt investor confidence.

Ten-year gilt yields climbed 6 basis points to 4.974%, Tradeweb data show. Sterling fell 0.2% to $1.3601. The euro rose 0.1% to 0.8651 pounds after reaching a near two-week high of 0.8670 pounds overnight, according to LSEG data.

Analysts have said that should a more left-leaning Labour leader replace Starmer, it could lead to increased government spending and worsen public finances. Such a development could cause investors to add a risk premium on U.K. government bonds.

"Signs of fiscal slippage may see investors demand higher compensation for holding U.K. government debt, which could push borrowing costs higher," UBS economists Dean Turner and Maelle Quillevere said in a note.

Markets worry that political uncertainty could hurt investor confidence and push the U.K. into a vicious cycle of high borrowing costs and sluggish growth.

"The demand for higher term premium [the premium demanded for buying long-dated bonds] leaves the government at risk of a toxic fiscal spiral of low growth and higher borrowing costs whereby worries about fiscal policy lead to higher borrowing costs," Barclays fixed income strategist Moyeen Islam said in a note.

Labour lawmaker Catherine West said in an interview with the BBC on Sunday that she could challenge Starmer's leadership if she was still dissatisfied after his speech.

"The writing appears to be on the wall" for Keir Starmer's premiership, and it is now more a question of how long he can cling to power, MUFG Bank senior currency analyst Lee Hardman said in a note.

Former Deputy Prime Minister Angela Rayner appeared to throw support behind Greater Manchester Mayor Andy Burnham over the weekend. She said it was a mistake to block Burnham from standing in a special election earlier this year that would have paved the way for him to return to parliament and potentially challenge Starmer.

In September Burnham said that the U.K. should no longer be "on hock to the bond markets," causing gilt yields to rise. While he subsequently downplayed the remarks, "this is something to watch carefully as we navigate the politics of the next few days and weeks," Deutsche Bank analysts said in a note.

"Any contest could easily drag on for months, leaving the U.K. facing a prolonged period of political uncertainty, with the government's direction and economic policy in flux until at least the autumn," UBS economists said.

Write to Miriam Mukuru at [e-mail] and Renae Dyer at [e-mail]

(END) Dow Jones Newswires

05-11-26 0703ET