The spectre of a bond market meltdown is haunting Westminster as Keir Starmer's leadership teeters. A rise in borrowing costs and warnings to avoid a 'Liz Truss moment' have put investors on edge, with the yield on 30-year UK government bonds briefly hitting 5.8% on Tuesday, the highest since 1998.
Political Instability Fuels Sell-Off
Amid febrile conditions in Westminster, the prospect of Britain switching prime ministers for a sixth time in seven years has sparked a sharp sell-off in UK government debt. Selling pressure has been maintained on gilts relative to G7 peers, as investors fear a return to political instability and a leftward shift by Labour involving higher borrowing.
'The markets hate uncertainty, but they hate a political vacuum even more,' said Nigel Green, chief executive of deVere Group. 'A cabinet resignation followed by a leadership fight would signal that the government is losing control of itself while investors are already questioning the country's fiscal direction.'
Labour MPs Divided on Fiscal Approach
Within Labour ranks, many MPs are sanguine, reflecting frustration at Starmer's tight approach to tax and spending despite plunging poll ratings. Starmer's allies argue that avoiding bond market provocation should be reason enough to save him, but others appear willing to test the City's warnings.
Merseyside MP Paula Barker, an ally of Andy Burnham, suggested financial markets would 'have to fall into line' if Burnham found a route to Downing Street. Meanwhile, leftwing grandee Diane Abbott suggested that MPs 'might as well go home' if bond market considerations trumped other priorities.
Investors Warn of 'Another Liz Truss Moment'
Investors warn that a contest ignoring the fragile state of public finances could prove fatal for any candidate. 'If the political leadership changes or if current leaders opt for substantially more fiscal loosening, the risk is high that we would see another Liz Truss moment,' said Reto Cueni, chief economist at Syz Group.
The backdrop is precarious. Government borrowing costs worldwide have risen amid the mounting economic damage from the Iran war, but Britain has been singled out due to its political instability. UK national debt stands at almost 100% of GDP, the highest since the 1960s, while debt servicing costs have risen with global interest rates.
Goldman Sachs: Policy Constraints Remain
Analysts at Goldman Sachs noted that any successor to Starmer would face the same challenges. 'Policy choices will remain constrained by the challenging backdrop of rising spending pressures and an already elevated tax burden irrespective of any changes in leadership.'
Further borrowing on top of planned bond sales worth £252bn this year would risk driving gilt yields higher, adding to Britain's £100bn-a-year debt interest bill. Mark Dowding, chief investment officer at RBC BlueBay, warned of a 'vicious spiral' where fear of higher borrowing costs drives them even higher.
Balancing Act Ahead of Leadership Race
Most City investors expect those vying to replace Starmer to strike a balance between shifting direction and keeping the bond market onside. Louise Haigh, co-chair of the Tribune group, set out a plan allowing higher borrowing by overhauling fiscal rules, but warned changes must wait until Labour meets Reeves's target of balancing day-to-day spending with tax receipts.
'This is not to say we should disregard the bond markets or pursue reckless borrowing – far from it,' Haigh wrote. Some analysts expect Labour to retain Rachel Reeves as chancellor to reassure investors, given her reputation with the City.
Jordan Rochester of Mizuho said: 'I suspect the new leadership will attempt to calm down markets with a few words. But the party is shifting to the left and the market will price that in first.'
