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Speculation over Keir Starmer’s future has unleashed a fresh round of market unease, with investors dumping the pound, UK equities and long-dated government bonds amid the political uncertainty.
The gulf in price between the UK’s short- and long-term debt – known as the yield curve – reached its highest since 2018, in a sign investors were losing faith in the long-term credibility of the UK economy even as the interest rate outlook improved.
Yields of the two-year gilt, which tracks Bank of England decisions more closely than longer-dated bonds, fell sharply after the Monetary Policy Committee held Bank rate at 3.75 per cent in a vote that was far narrower than most economists had expected.
But interest rates on the 10-year gilt, the main benchmark for a government’s long term capacity to borrow, remained elevated, as investors priced in the prospect of a more spendthrift leader replacing the Prime Minister.
The sell-off took the gap between the two securities to over 95 basis points, its highest in nearly eight years. Traditionally, the prices of two- and 10-year bonds – which move inversely to their yields – broadly track each other, becoming unmoored when investors lose faith in – or are especially optimistic about – the UK’s inflation and fiscal outlook.
Traders also offloaded holdings in the UK’s 30-year coupon – the UK’s longest-dated bond that is least correlated with interest rates – taking its yield to the highest since November despite a move by the government agency responsible for auctions of UK bonds to reduce their supply.
“Long gilt yields remain tied to UK political risk,” David Zahn, head of European fixed income at Franklin Templeton, told City AM. “While we had anticipated political risk later in the year, it seems to be coming forward in the calendar.
“Gilts are beginning to price in a potential change in Labour government and the prospect of further fiscal loosening requiring additional gilt issuance.”
Sterling also sold off in parallel, even before the Bank of England’s interest rate decision. Lower interest rates tend to cause international investors to sell down their positions in a currency, because of the lower yield it is likely to attract from a bank. The pound was trading down 0.86 per cent on the dollar, falling to its lowest rate this month.
Reeves and Starmer continuity ‘keeps bond yields down’
Only the Norwegian krone, which was sold off aggressively amid falling oil prices, performed worse than sterling.
The FTSE 100 fell 0.94 per cent over Thursday’s session, with losses outstripping those made on Europe’s other blue-chip indices.
Nigel Green, the chief executive of Devere Group, said: “Rachel Reeves’ credibility with bond markets has been built on one core thing: continuity.
“She’s consistently positioned herself as a guardian of fiscal discipline, clear rules and predictability, particularly after the gilt market turmoil of recent years, especially during the Truss mini-Budget drama.
“This credibility is derived from the authority of the Prime Minister who empowered her and enforced discipline around the economic message.”
The jitters come as Keir Starmer remains engulfed in a scandal surrounding his appointment of Peter Mandelson to US ambassador despite his ties to convicted sex trafficker Jeffrey Epstein. The saga has left the PM’s premiership hanging by a thread, with several Labour MPs publicly calling for his resignation.
The fiasco has brought an abrupt end to what had been a positive period for major UK assets. Before Thursday, government borrowing costs had come down by more than 20 basis points – or a fifth of a percentage point – since September, easing the pressure on the public finances.
So far this year, the pound has also strengthened, benefiting from international investors hedging away from the dollar. The FTSE 100 has also notched up a string of record highs.
