UK’s would-be PM tries to placate bond markets after sell-off

U.K. gilt yields steadied on Monday after coming under heavy selling pressure last week, as traders gauge whether a challenge to Prime Minister Keir Starmer’s leadership poses a threat to the country’s fiscal stability.

As bond markets opened on Monday morning, the yield on the benchmark 10-year bond, or gilt, stood at 5.15%, easing by 2 basis points. Last Friday, the yield on 20 and 30-year gilts rose to their highest levels since 1998. On Monday, the interest rate on the 30-year gilt remained elevated, but also fell 2 basis points to at 5.83%.

U.K. borrowing costs have been under pressure since nationwide local elections saw the ruling Labour Party perform badly, promoting calls for Starmer to stand down.

Starmer has so far refused to resign, but he now faces potential leadership challenges from several Labour colleagues, including his former Health Secretary Wes Streeting, his former deputy Angela Rayner and Greater Manchester Mayor Andy Burnham.

The uncertainty in British politics has put bond markets on edge as investors consider whether a new PM will loosen self-imposed fiscal rules limiting borrowing and spending.

Burnham, who is thought to be on the left of his party, looked to reassure investors at the weekend that the U.K. government’s fiscal policies would be in safe hands were he to become PM, rowing back on previous comments in which he appeared to suggest the country was “in hock to the bond markets.”

“I have never said you can just ignore the bond markets,” Burnham told ITV News at the weekend.

“I said politicians had placed Britain in hock because of the way in which we lost control of our finances and public spending when we handed away control of energy, water, housing,” he added.

Lizzie Galbraith, senior political economist at Aberdeen, told CNBC on Monday that an “extra risk premia” has been attached to U.K. gilts.

“One of the factors there is just the uncertainty of it all. We don’t yet have a leadership contest underway … [but] we’re potentially looking at months here of policy debate, policy uncertainty, and markets trying to predict where the Labour Party may move if we do get that eventual leadership challenge, as would appear to be the intention of major figures in the party at this stage,” she told CNBC’s “Europe Early Edition.”

The road for Burnham to replace Starmer is not a smooth one.

First, he needs to become a member of parliament to be able to challenge for the leadership. While he has been given the green light to contest a by-election in Makerfield, in the north of England, victory is not guaranteed, as rival parties line up to contest the seat.

Deutsche Bank analysts said Monday that despite Burnham’s walking back of comments on the bond markets, investors “are likely to fear higher fiscal spending with Burnham as PM.”

“So the focus is now on that by-election, which the BBC have reported will be on June 18. There’s no guarantee he will win the by-election, as it’s a marginal seat for Labour and Nigel Farage’s Reform UK performed very strongly there at the local elections earlier this month. Much will depend on how aggressively the Green Party contests the seat and splits the left-wing vote,” the analysts noted in emailed comments.

The debate over Brexit, the U.K.’s departure from the European Union, is likely to re-emerge in the scrap for Leave-voting constituency Makerfield, with Reform UK likely to focus on Burnham’s former support for remaining in the bloc ahead of the 2016 referendum.

Carsten Nickel, managing director at Teneo, told CNBC that markets should prepare to see Brexit used once again for “short-term politicking” rather than an indication of longer-term policy direction.

“The only thing I’d be interested [to hear] at this stage would be a longer-term debate in terms of where do [they] want to head as the Labour Party? Like some progressive consensus at the center, but that’s not there.”