The UK bond market is remarkably stable considering the Prime Minister is expected to face a leadership challenge from both the right and the left of the Labour party in the coming hours. Bond yields are backing away from their highs, as UK GDP drives sentiment towards UK debt. The UK’s 10-year yield remains above 5%, but it is lower by 6bps compared to Tuesday’s high.
The GDP report has eased some fears about the strength of the UK economy and its resilience in the face of an energy price spike. The economy grew at a 0.6% quarterly rate in Q1, and monthly GDP for March was 0.3%, beating expectations of a 0.2% decline. Defying the doom and gloom narrative that surrounds the UK right now, the economy saw a strong bounce back in services, production and construction in the first quarter of the year. Digging deeper into the details, the ONS said that computer programming and advertising were particularly strong performers, and construction also returned to growth, partly reversing the weakness at the end of last year.
More impressively, GDP per capita increased by 0.6% in Q1 2026, and is higher by 0.9% compared with a year ago. This suggests that there was some strong momentum in the first quarter, even though the picture looks like it has weakened as we have moved into Q2 and energy prices have remained elevated. The Prime Minister and his team are desperately trying to use this data to fend off leadership rivals, however, the UK’s economy has a seasonal predication to show strong growth in Q1, before weakening for the rest of the year. There are already signs that the private sector is under pressure, and the housing market is also struggling from rising mortgage rates. So, the outlook is not so rosy for the UK, and Q1’s economic data may not be repeated.
The reason why UK economic growth is seasonal could be due to delayed activity after the Budget. Leading up to the 2025 Budget in November, the government had sapped confidence from the economy by threatening tax increases, including income tax. Once the Budget was out of the way, confidence returned to the economy in the opening months of the year. The FX market is not buying into the strong UK economy story today, and the pound is down slightly as the dollar strengthens on a broad basis. GBP/USD is trading in a tight range around $1.3515. The FTSE 100 is eking out a gain today, but it also underperforming its European peers.
However, for the first time in the past week, the UK government bond market is stable, and is outperforming its global peers. UK yields remain elevated, but the bond market has been relatively stable in the past 24 hours. This could be because no other Labour Party member has made a formal leadership challenge against Starmer, or because thereby are reports that left of the party are planning on keeping Rachel Reeves as chancellor if Starmer goes. For now, we think that the selling pressure on UK bonds is on pause, and the sell off could start again if we get high tax/ high spend candidates standing against Starmer.
The good news is that if a political battle is prolonged and lasts until the autumn, then this limits the amount of political meddling from the PM and the Chancellor regarding the economy. This could shield the economy from a pre-Budget slump later this year, even as the PM battles to stay in his job.
Other details in this morning’s data are also worth watching, the UK’s trade deficit widened significantly in the first quarter, by £4.5bn to £7bn, and the services surplus narrowed. Increased refined oil imports from the Netherlands and higher car imports from Germany boosted the deficit between the UK and the EU last quarter. If services growth does not stay elevated in Q2, then a widening trade deficit could come back to bite the UK’s growth rate later this year.
Elsewhere, the dollar is strengthening broadly on the back of expected Fed hikes in the coming 12 months. Kevin Warsh will formally take over as chair of the Federal Reserve from Jerome Powell tomorrow, and hopes that he can cut interest rates have been dashed as inflation data for April has come in hot. This has not stopped US indices from making fresh record highs, and futures markets are climbing once again today. The oil price is higher, but this is not dampening the market mood in Europe. However, the UK index has been weighed down by its lack of tech, which is driving a global stock market rally, and weak earnings from 3i and Burberry, which have both seen their earnings come under pressure from the war in the Middle East.
Overall, the bond and stock markets are showing remarkable resilience today, and US stocks are set to open at resh record highs later on Thursday. Politics and a recalibration of interest rate expectations are both failing to dampen the market mood. The question now is, how long can it last?
UK 10-year bond yield, 1 month chart, the yield has backed away from recent highs
Source: Trading View