Downing Street resignations trigger bond market jitters

Nervousness rippled through UK bond markets on Monday after a series of Downing Street resignations concentrated minds on the uncertain future of prime minister Sir Keir Starmer.

The 10-year gilt yield – a key benchmark for the government – jumped as much as 10 basis points to 4.62 per cent in the early afternoon following news that Scottish Labour leader Anas Sarwar would give a speech calling for Starmer to quit.

That came shortly after the resignation of Downing Street communications chief Tim Allan, the second such departure of a close Starmer aide in 24 hours following the exit of chief of staff Morgan McSweeney on Sunday. 

The intra-day bond moves pushed 10-year yields above last week’s peak of 4.6 per cent to hit a three-month high. But calm later pervaded markets after key cabinet allies rallied around Starmer and shook off any prospect of his imminent departure, causing yields to end the day only slightly higher at the close of the trading session.

Kathleen Brooks, research director at XTB, said: “This is likely to be an unsettling time for UK bond investors, as any successor could push UK economic policy further to the left, which may trigger a selloff in UK debt. In the past month, a political risk premium has been added to UK long-end debt, and the 10-year Gilt is the worst performer in Europe and is underperforming the US.”

Yield curve in focus

Over the past week, nerves have engulfed the bond market in a sign investors were betting against the stability of the Starmer government.

The gulf in price between the UK’s short- and long-term debt – known as the yield curve – reached its highest since 2018 last Thursday, in a sign investors were losing faith in the long-term credibility of the UK economy even as the interest rate outlook improved.

Ruth Gregory, deputy chief UK economist at Capital Economics, said any replacement to a Starmer administration could “pivot to slightly looser fiscal policy and decide to live with higher borrowing costs.

“The issue is that the longer this lasts, the greater the risk of a bigger sell-off in the gilt market eventually, which could force the government into a more abrupt fiscal tightening.”

If a more left-leaning top team were to replace Starmer, a weakening of the fiscal guardrails and promises of big increases in both public spending and borrowing could trigger a bigger initial spike in 10-year yields to north of 5 per cent, Gregory said, and a bigger initial fall in the pound to as low as $1.20.