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As dire results rolled in for Labour on Friday, with Sir Keir Starmer defying calls to step down with warnings of “chaos”, gilt traders took the view that the local elections could have been worse for the prime minister.
The UK’s 30-year borrowing costs — which reached a 21st-century high this week in part due to concerns about the fragility of Starmer’s premiership — dropped 0.08 percentage points to 5.57 per cent as the debt rallied on Friday. French and Italian bonds, which have mostly traded in tandem with gilts during the Iran war, were unchanged.
Sterling also received a boost, gaining 0.4 per cent against the dollar to trade at $1.361.
Investors on high alert for a Labour leadership challenge or shift left that drives up government borrowing said the early results were not the “doomsday scenario” that would make Starmer’s departure a foregone conclusion and catalyse a sell-off. But it was a reprieve following a weak run for gilts rather than a relief rally, they said.
“Starmer gaining time is enough for yields to stay stable,” said Gordon Shannon, a fund manager at TwentyFour Asset Management. “But there is still a tonne of recent underperformance left in the price.”
While the impact of London seats was yet to be felt, fund managers said the initial vote returns also did not support the idea of a Green Party wave that would be big enough to drag Labour to the left and imperil Starmer and his chancellor Rachel Reeves.
The Greens “haven’t done as well as some had feared, so that tail risk is somewhat off the table”, said Lloyd Harris, head of fixed income at asset manager Premier Miton.
But the gains for 30-year debt unwound only some of the underperformance to other markets that had built up in recent weeks, as the political concerns put pressure on the debt already suffering as rising oil prices fuelled expectations of UK interest rate increases.
Thirty-year gilt yields are still up about 0.5 percentage points since the Middle East conflict started, compared with 0.3 percentage points for French debt of the same maturity.
After Starmer’s pledge to stay on, investors continue to closely watch the reaction of senior Labour figures and potential challengers.
Starmer has not “thrown in the towel” but “we still expect a challenge to his premiership at some point”, said Premier Miton’s Harris, adding that he was reluctant to add gilt market exposure as a result of the political backdrop for Starmer remaining “challenging”.
A big source of uncertainty for the market is the lack of a clear challenger to Starmer who is in position to move against him. The bookies’ favourite, Greater Manchester mayor Andy Burnham, does not currently hold a parliamentary seat, while former deputy leader Angela Rayner is unpopular with the public.
“Potential successors remain fragmented and constrained by the familiar problem that leadership challenges often damage the challenger as much as the incumbent,” said James Carter, co-head of fixed income at investment manager W1M. “For many potential successors, removing him now risks inheriting a poisoned chalice.”
FX traders held on to their short-term bets against sterling: so-called risk reversals in euro-pound, which reflect traders’ short-term bets on the currency pair, remain skewed against the pound.
The currency has been resilient in recent weeks as gilt prices have fallen, supported by the market moving to price in interest rate increases from the Bank of England.
But investors warn a leadership challenge from here could trigger sterling weakness at the same time that gilt volatility jumps.
“If this poor showing for Labour does end up triggering a leadership challenge,” said Francesco Pesole, a strategist at ING, “the negative impact can be quite severe”.
