Bond investors and analysts have warned that Angela Rayner's economic response to Labour's bruising local elections defeat would trigger a sell-off in UK government debt at a time when Britain's borrowing costs are already at multi-decade highs.
Rayner's Economic Proposals
The former deputy Prime Minister laid out a detailed proposal for how her party should respond to Thursday's historic defeat at the ballot box. The plan included "immediate action to cut costs for households" and a windfall tax on energy firms. However, several fixed income experts told City AM that the platform proposed by the Labour leadership contender would constitute a "toxic mix" that a gilt market already under pressure from the Iran war would struggle to afford.
Fiscal Rules Under Scrutiny
Matthew Amis, investment director at Aberdeen Investments, said, "It's a struggle to see how she stays within the fiscal rules. So the conclusion from the gilt market would be that it's going to be a struggle." Amis added that the easiest way for any leadership contender to lower the borrowing costs they inherit is to prove they have a plan to "answer the tough questions on spending."
In a lengthy social media post on Sunday, Rayner unveiled a slew of tax and spend measures that she argued would restore her party's relationship with working class voters. She insisted the measures would fall within the Treasury's current fiscal rules by "ensuring those who benefit from the crisis contribute more so that everyone can thrive."
Investor Skepticism
Richard Carter, fixed income analyst at Quilter Cheviot, warned that even if the plans fell within the government's self-imposed spending straitjacket, "gilt investors are likely to remain sceptical about the overall policy mix." He added, "Further increases in the tax burden are also unlikely to do much to stimulate growth. Investors would welcome an end to the current political uncertainty and leadership speculation, but whoever takes over will still have to confront the UK's fiscal constraints fairly quickly."
Borrowing Costs at Multi-Decade Highs
UK government bonds have come under immense pressure across the curve since the onset of the conflict in the Middle East. Both short- and long-dated government bonds have sold off dramatically, with investors fearing the protracted closure of the Strait of Hormuz will stoke a fresh bout of inflation and dent Britain's already anaemic growth prospects.
The yield on the 10-year gilt, the benchmark for a country's long-term ability to borrow, has climbed by nearly a full percentage point since the US's first strike on Iran and is now at levels not seen since the financial crisis. Two-year gilt yields, which track investor projections for central interest rates closely, have risen by more than a full per cent over the same period.
Downward pressure on bonds, whose prices move inversely to their yields, was further stoked by rampant speculation over Keir Starmer's future, with gilt investors fearing any replacement would initiate a more left-leaning economic agenda.
Expert Warnings
Helen Thomas, chief executive of political economy research house Blonde Money, said Rayner's plans for more draconian wealth taxes and greater public ownership look like "a plan for inflation and unproductive growth." She told City AM, "It is precisely the kind of toxic mix that a gilt market already facing the stagflationary impact of the Iran war can ill afford."
In a research note on Monday, Jefferies analyst Modupe Adegbembo said protracted leadership speculation would cause the yield curve to steepen, meaning long-term borrowing costs would become even more expensive for the government to issue than short-term debt. "Heightened fiscal uncertainty and rising leadership risk argue for higher term premia," she said, referring to the increased yield bond traders demand for holding long-term debt, usually on the grounds of a government's fiscal imprudence.
