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Bond traders are bracing for the prospect of a surge in gilt yields as uncertainty over the future of Keir Starmer’s term in office could pave the way for a more left-wing successor.
A Starmer defenestration could be just weeks away amid renewed scrutiny over the botched appointment of Peter Mandelson as Washington ambassador and a high chance Labour will haemorrhage hundreds of councillors at May’s local elections as the party languishes in the polls.
Any replacement for Starmer is widely viewed as likely to come from the left of the party, triggering rising bond yields as investors reel from a government spending splurge.
In an interview with City AM, Mike Bell, head of market strategy at RBC BlueBay Asset Management, said: “If you look at the bookies at the moment, they’ve got [Angela] Rayner as the favourite – that’s clearly a shift to the left relative to a kind of more center left government at the moment.
“It’s possible that under a more left leaning government, you get a combination of tax increases as well as more spending.
“I think markets will assume that you’ll have some fiscal loosening in that position. And with that you could potentially see gilt yields rise.”
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Bond yields highest in the G7
UK government bond yields are already the highest in the G7, thanks to a combination of higher inflation, higher central bank interest rates and the UK’s sizable exposure to the economic fallout from the war in Iran.
Earlier this week the government’s Debt Management Office (DMO) sold 10-year bonds at the highest yield since the global financial crisis.
But a more radical left-wing government could add an additional risk premium to UK bonds, pushing yields up further still.
“If the government does come out with a material fiscal package by breaking its fiscal rules, then that would obviously mitigate some of the growth shock,” said Cosimo Codacci-Pisanelli, a managing director in EMEA interest rate product sales at Goldman Sachs.
“And I think we would be in a very bearish rates environment again and flip back to talking about fiscal sustainability and the possible risks of a bond market tantrum of some kind.”