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UK borrowing costs spike as Starmer's future hangs in balance
Uncertainty over Prime Minister Sir Keir Starmer's leadership sent UK government borrowing costs soaring on Tuesday, with 10-year bond yields briefly hitting 5.13%-levels not seen since the 2008 financial crisis.
Market jitters over fiscal policy and inflation
Investors grew nervous as concerns mounted over potential leadership changes within the Labour Party, which could lead to looser public spending. The turmoil was compounded by fears that rising oil prices, driven by the Iran war, would fuel inflation and prompt interest rate hikes.
The FTSE 100 opened over 1% lower but recovered slightly to close down just 0.04%. Banking stocks, including Lloyds, NatWest, and Barclays, fell amid speculation of future tax increases under a new administration. The pound also weakened, dropping 0.5% against the dollar to $1.35.
UK rates outpace peers as investors demand higher returns
While global borrowing costs have risen since the Iran conflict pushed oil prices above $100 a barrel, the UK has faced steeper increases than similarly sized economies. Analysts warn that potential successors to Starmer-such as Andy Burnham, Angela Rayner, or Wes Streeting-could adopt more expansionary fiscal policies, further unsettling markets.
"The UK's already fragile fiscal position means investors will be on edge for any signs of fiscal loosening," analysts at Capital Economics said. "The likely replacements for Starmer and Chancellor Rachel Reeves would probably not be as fiscally disciplined."
Bond yields hit multi-decade highs
On Tuesday, yields on UK government bonds-known as gilts-rose across all maturities as Starmer's leadership came under scrutiny. The 30-year yield reached 5.81%, its highest level since 1998, while the 10-year gilt, a key benchmark, briefly touched 5.13%. Shorter-term bonds, which influence fixed-rate mortgages, also saw sharp increases.
Anna Macdonald, investment strategy director at Hargreaves Lansdown, noted that bond markets were "frazzled" by the prospect of a new prime minister relaxing fiscal rules. "Investors, including overseas buyers who hold 25-30% of UK gilts, will demand a higher risk premium if they perceive greater uncertainty," she said.
Inflation and debt costs weigh on government spending
Governments typically borrow to cover spending gaps not met by tax revenues, issuing bonds to investors. However, when markets perceive higher risk, they demand greater returns. The UK's debt interest payments, tied to inflation and bond yields, now consume roughly £1 in every £10 of public spending-a growing burden amid rising costs.
Though UK borrowing costs rose more sharply than those of France and Germany, analysts attribute much of the global increase to inflationary pressures from surging energy prices.
