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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is author of ‘Blood and Treasure, the Economics of Conflict from the Vikings to Ukraine’
On the day Sir Keir Starmer announced he was set to leave Downing Street, clearing the way for the seventh UK prime minister in a decade, the yield on ten-year gilts fell a little. The move was not especially noteworthy. Had they risen, however, it would no doubt have featured in much of the day’s political coverage as evidence that financial markets were fretting about the prospect of Andy Burnham taking power. In recent months daily moves in the gilt markets have featured far too prominently in British politics. But, perhaps just as importantly, gilt investors have spent far too much time needlessly worrying about British politics.
Towards the end of February, before the US and Israel attacked Iran and when the Strait of Hormuz was still operating as normal, ten-year gilt yields had dipped as low as 4.23 per cent. By late April, amid fears of a serious oil price shock, they had risen almost an entire percentage point to a peak of 5.20 per cent. Much of the commentary during this time played up political risks and uncertainty. Labour’s devastating losses in elections in England, Scotland and Wales in May seemed to seal Starmer’s fate.
Investors supposedly feared that a more leftwing successor such as Burnham might rip up the fiscal rules (he has since said he will stick to them), increase borrowing and drive inflation and yields higher. The then-Mayor of Manchester’s comments, made last autumn, about not being “in hock” to the bond markets frayed more than a few nerves. Meanwhile, the experience of both the Brexit referendum in 2016 and the rolling crisis that was Liz Truss’s shortlived premiership in 2022, have left international investors on alert that UK political developments have the potential to hit the value of domestic assets.
In reality, though, the sell-off in government bonds that played out over the course of March, April and May had rather less to do with domestic politics and rather more to do with the closure of the Strait. The structure of the UK electricity market means it is especially exposed to international energy price shocks, which feed through quickly into inflation. Having previously expected the Bank of England to cut interest rates in 2026, markets moved quickly to price in multiple rate hikes and the central bank, playing a wait-and-see game, declined to push back strongly against this expectation. The results were painful for gilt markets.
The National Institute of Economic and Social Research dissected the move in yields in a report at the end of May. It found that the large increase was almost entirely the result of oil price moves and wider turbulence in global bond markets. Those factors had pushed up the yield on 30-year gilts by around 0.6 percentage points while increased political risk had added just 0.06 percentage points to longer-dated yields.
The global macro environment now seems a little more benign than just a few weeks ago. The downside risk of a surge in oil prices towards $150 a barrel has diminished and the worst-case scenarios do not seem to be materialising. What is more, the latest data on the UK labour market does not show much evidence of inflationary pressure. It looks, at best, sluggish and pay pressures are falling. Unlike in 2022, when the jobs market was still running hot in a post-lockdown hiring boom, the BoE is unlikely to be forced into an aggressive hiking cycle.
Even after their recent rally, gilt yields still look attractive relative to many international peers. That likely represents some lingering fears about developments in Westminster. Such risks are overplayed. The prospect of Burnham becoming prime minister through a coronation rather than a contest, in which he might have been pressured into making expensive promises, should help calm market jitters.
Burnham may well end up tweaking the fiscal rules in the coming years. But this would not be anything out of the ordinary. Fiscal rules have been changed more than half a dozen times since 2010. As long as the framework is credible in the medium term, markets will adjust. What he will not do is carry out a major fiscal loosening — especially without any scrutiny from the Office for Budget Responsibility — in the face of already sharply rising inflation. A repeat of the Truss episode is simply not on the cards.
UK politics has been unusually dramatic over the past decade. Sometimes this drama has spilled over into asset prices, but most of the time it has not. Fears about political risk in the gilt market are overdone.
