Gilt finds it easy as UK Prime Minister Starmer says he won’t quit after the election

Early results from local council elections showed a heavy loss for the UK’s ruling Labor Party on Friday, raising questions about Keir Starmer’s future as prime minister.

Bond watchers have been watching his fate in recent weeks, and the results are expected to fuel speculation that the prime minister could be ousted by his party.

The vote count indicates that hundreds of Labor councilors lost their seats and the leadership of many councils changed hands.

Speaking to reporters as results continued to roll in on Friday, Starmer labeled the result “really tough.”

“Voters sent a message about the speed of change, how they want their lives to improve,” he said. “Labor was elected to address those challenges, and I’m not going to go … and throw the country into chaos. It was a five-year term that I was elected to serve, [and] I’m willing to see that.”

It produces on the benchmark 10 years UK government bonds, known as gilts, were nearly 6 points down at 4.888% at 10:38 a.m. in London on Friday, falling in response to Starmer’s insistence that he would not step down.

The predicted election result will not affect the make-up of parliament at Westminster or a change in government, but it does reflect a dismal feeling about Starmer’s leadership among the electorate.

Labor and the opposition, the Conservatives, are expected to lose the most, while Reform UK and the left-wing Green party are expected to gain the most.

Backbench Labor MPs – MPs without government positions – are reportedly planning to blame the Prime Minister for the impending loss and demand he step down.

In a morning note on Friday, a team of Deutsche Bank analysts led by Jim Reid said the UK would be a focus for investors as the outcome of the election becomes clearer.

“Today, it will be important to watch what MPs and Cabinet ministers have to say, as gilt markets focus on whether PM Keir Starmer will remain in office following the results,” they said.

“That’s because of the expectation that the new Labor leader can ease financial regulations and increase gilt issuance, so if Starmer’s position is called into question, that’s accompanied by a sell-off in gilts.”

The full results of the election will not be known until Saturday afternoon, when all the councils that held the election are expected to announce their results. The Scottish Parliament and the Welsh Senedd, which preside over their own devolved governments, are expected to announce the full results on Friday evening.

Starmer and his finance minister, Rachel Reeves, have been fighting discontent over monetary policy within their ranks, while social reform and the appointment of Peter Mandelson – the late sex partner of Jeffrey Epstein – as US ambassador, have further damaged relations between the parties.

Health Minister Wes Streeting, former Deputy Prime Minister Angela Rayner and Greater Manchester Mayor Andy Burnham are reportedly among the top contenders to replace Starmer. Rayner and Burnham – who is currently ineligible to be prime minister because he has no seat in parliament – are seen as more left-wing than Starmer.

But markets have been supportive of Starmer and Reeves retaining their positions against potential rivals, while UK bonds have sold off in previous periods of uncertainty over their political future.

Last July, yields on UK government bonds – known as gilts – rose after Reeves was seen crying in parliament, amid reports that his role in Starmer’s cabinet was at risk. This happened after the government introduced a proposal for welfare cuts following the defection of Labor politicians.

Earlier this week, gilt yields rose to their highest levels since 2008 amid reports of a planned coup against Starmer in his party after the election.

Bond yields and prices move differently.

Gilt yields were lower across the curve on Friday, with the 2-year yield shedding 5 points while the 20-year and 30-year yield lost 9 and 8 points, respectively. Long-term yields rose again to a decade high earlier this week, with 30-year borrowing costs touching their highest level since 1998.

Dan Coatsworth, head of markets at AJ Bell, said in a statement on Friday morning that the 30-year yield is a better political measure than the 10-year rate, as the UK government often issues longer-term debt.

“The 30-year yield held firm at 5.628%, as it traded at 5.8% earlier this week versus 5% three months ago,” he said.

“The election results have fueled speculation that Keir Starmer may struggle to hang on as prime minister. Bond markets have been jittery on the prospect of a political shake-up as the outspoken opposition, Angela Rayner and Andy Burnham, may seek more government borrowing and spending, which could take yields even higher.”

The UK already has the highest government borrowing costs in the G7, with its 10-, 20- and 30-year yields above the key 5% threshold. The yield is a good representation of the interest paid by the government to its debt investors.

Freya Beamish, chief economist at TS Lombard, told CNBC’s “Squawk Box Europe” on Friday that “politics really care about yields,” adding that it will be difficult for Labor to shift to “budget growth” policies against a backdrop of rising prices and economic constraints.

“The gilt market will certainly react badly if we ‘spend our way out of this’ without dealing with any kind of waste there, or ‘let’s cut taxes,’ which would be a form of growth policy, but you can’t just do growth policy without dealing with…

“And we know there must be some waste there – even as a percentage of GDP, many departments and many types of government spending are higher now than before Covid.”

Nigel Green, CEO of deVere Group, told CNBC early Friday that gilt markets are “very sensitive to political authorities, especially when governments are already facing difficult financial conditions.”

“Rachel Reeves is completely tied up in politics and Starmer in the economy,” he said. “If yields remain under pressure while labor suffers heavy electoral losses, investors may begin to conclude that the government is weakening politically and facing financial problems.”

Jonathon Marchant, fund manager at UK-based Mattioli Woods, told CNBC that the first indication is “it could be a tough day for Kier Starmer.”

“Given the tensions in the Middle East overnight and the oil-related impact and inflation, dispelling the market’s view of local elections is a challenge,” he said. “Gilt stocks opened slightly lower, the market appears to have priced in a negative Labor result ahead of the local election.”

Marchant noted that Starmer “has remained strong in recent weeks and may want to fight.”

“Certainly, we can see the pace of trying to change policy accelerate,” he told CNBC. “However, in the markets the question is: ‘which way?’ A move to the left is likely to appease the backbenches and stifle internal opposition and while this would be better than a change of leadership, it is not something the markets are likely to accept. “