Political uncertainty is continuing to cast a shadow over UK gilt markets, with questions persisting over Prime Minister Starmer’s leadership at a delicate moment for the economy.
For bond investors in particular, the timing is awkward: inflation is expected to fall sharply in the months ahead and the Bank of England appears poised to begin cutting interest rates as early as March. Against this backdrop, speculation over a potential Labour leadership contest risks unsettling gilt markets just as conditions might otherwise have been turning more supportive. Following the departure of key staff from No 10 in early February, the pressure on Starmer increased significantly. However, as we headed towards mid-February, it appeared that this has subsided to a degree. This could all change with the Gorton and Denton byelection later this month and of course to May, when the local elections in England and elections to local assemblies in Scotland and Wales, could potentially cause more turbulence. UK gilt investors will have their eyes firmly on political events as well as economic data.
In the following analysis, Charlie Lloyd, Head of Investments at Shackleton Advisers tells us why all this uncertainty might prove to be particularly important for UK gilts in the weeks and months ahead.
As Lloyd explains, uncertainty over Keir Starmer’s future is unhelpful for UK bond markets, particularly since inflation is on track to fall quite sharply in the coming months and the Bank of England appears to be gearing up to cut interest rates as soon as March, with one or two further cuts later in the year.
Political risk resurfaces for gilt markets
Bond market fears at this juncture are somewhat understandable, given that some of the potential replacements for the Prime Minister, most notably Angela Raynor, sit politically to the left of Keir Starmer. However, with the cabinet rallying behind the Prime Minister, at least in the short term, it would appear that the worst fears of bond markets may be avoided until after the local elections in May, assuming Starmer can survive until then.
The most obvious replacements, Wes Streeting and Angela Raynor, also face issues of their own. In the case of Streeting, his close association with Peter Mandelson, whilst Raynor awaits the results of an HMRC investigation. Taking over the Labour party before the local elections is also an unattractive proposition given current polling.
The local elections are likely to be a referendum on Keir Starmer and the Labour government, and a poor result could result in another attempt to oust Starmer. A leadership contest would almost certainly lead to short-term volatility in UK bond markets and an increase in the cost of borrowing through higher yields. A prolonged contest could impact the economy if gilt yields traded at a premium to other bond markets for an extended period, not to mention the potential impact on consumer confidence.
Leadership uncertainty and fiscal credibility
Backbench MPs have little appetite for fiscal reform, given a series of u-turns on recent tax and spending announcements, including efforts to reduce the welfare bill. A leadership contest therefore increases the likelihood of further fiscal profligacy, which may complicate the Bank of England’s task.
Why the Chancellor choice may matter most
However, we’d also expect that any potential replacement for Keir Starmer would be aware that bond markets represent a threat to political stability and economic credibility, therefore requiring a market-friendly Chancellor. In some respects, the appointment of Chancellor is as important as the next Prime Minister, as least from an investor perspective.
Wes Streeting is perceived as the most bond market-friendly of the potential challengers and would be seen as a continuity candidate, as would Shabana Mahmood, whereas Andy Burnham could cause significant concern and bond market angst, given his perceived position as sitting decidedly on the left wing of the Labour party.
About Charlie Lloyd
Charlie is Head of Investments at Shackleton Advisers. He started his career with HSBC Investments and UBS Wealth Management before joining Brewin Dolphin, where he worked in their Brighton and Reigate offices. He joined the team in April 2017 as an investment manager and became head of investments at the end of 2019.
