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United Kingdom gilts had a brutal week, and British politics had an even worse one. Starmer says he is staying. Bond markets are relieved, but only barely, and only for now.
Labour suffered heavy losses in Thursday's local elections, losing control of at least eight councils as Reform U.K. made significant gains across the country. Early results pointed to hundreds of Labour councillors losing their seats, with the Conservatives also taking a beating and left-wing Greens picking up ground.
Starmer responded by vowing to stay in post. Speaking to reporters on Friday, he said he would not walk away and plunge the country into chaos, and that he intended to see through the five-year term he was elected to complete. Gilt yields, which had surged to multi-decade highs earlier in the week on speculation of an imminent leadership challenge, fell in response. The 10-year yield dropped around 5 basis points to 4.88%, a two-week low. The 30-year yield, which had touched 5.79% earlier in the week, its highest since 1998, retreated to around 5.55%. Sterling rose 0.5% against the dollar to $1.36.
The moves reflected relief that the results, while damaging for Labour, were not the outright catastrophe that would have made Starmer's position immediately untenable. The Greens in particular did not perform as well as some had feared, removing one scenario in which a strong Green showing would have dragged Labour toward the left and put further pressure on the prime minister.
The week illustrated something important about where UK politics and markets now sit relative to each other, and it is not a comfortable picture.
Start with the gilt market itself. U.K. borrowing costs have been rising since the Iran war broke out in late February, driven by the same forces hitting bond markets globally: higher energy prices, inflation risk, and the prospect of interest rate increases rather than cuts. The Bank of England held rates at 3.75% in April with an 8-1 vote, but its own scenario analysis puts peak inflation anywhere between 3.5% and 6.2% depending on how the energy shock develops. Markets are currently pricing in two rate hikes by the end of the year. In that environment, gilts were already under pressure before anyone started worrying about Keir Starmer.
The political layer on top of that is what made this week genuinely alarming. UK 30-year borrowing costs have risen around 0.75 percentage points since the conflict began, compared with 0.3 percentage points for equivalent French debt. That gap reflects a UK-specific risk premium that is partly about energy exposure, since Britain relies heavily on natural gas for power and heating, and partly about political uncertainty. Every time Starmer's position has come under threat in recent months, gilts have sold off. The market has made clear that it views the prime minister and his chancellor Rachel Reeves as the guarantors of fiscal discipline, and that any successor, particularly from the left of the party, represents a threat to that.
The problem is that Starmer surviving Friday does not make this dynamic go away. The election results have weakened him without removing him, which is arguably the most unstable outcome for markets. Backbench MPs are unhappy, potential challengers are circling, and the political conditions for another push against his leadership are still in place.
Andy Burnham, widely seen as the frontrunner to replace Starmer, does not currently hold a parliamentary seat, which complicates any immediate challenge. Angela Rayner, another potential successor, is seen as unpopular with the broader public. The absence of a clear, credible challenger may be doing more to protect Starmer right now than any show of strength on his part.
Meanwhile the underlying fiscal picture remains difficult. The U.K. has the highest government borrowing costs in the G7, with 10-, 20- and 30-year yields all trading above 5%. Any shift toward looser fiscal policy, whether through increased spending commitments, softened fiscal rules, or an explicit break with Reeves's approach, would likely trigger another sell-off. The gilt market has essentially become a constraint on domestic politics, limiting the space available to any Labour leader who might want to respond to electoral pressure by spending more.
Most of the local election results, including Scotland and Wales, were still coming in on Friday, and the full picture may shift the political calculation further. Starmer has bought himself time, but the combination of a weakened parliamentary position, a hostile economic backdrop, and a bond market on a hair trigger means the pressure is unlikely to ease.
For gilt investors, the question is not whether this week's drama is over. It is what comes next to restart it.
Lloyds Banking Group (LLOY.L) — UK banks benefit from higher interest rates, which typically expand net interest margins.
NatWest Group (NWG.L) — UK banks benefit from higher interest rates, which typically expand net interest margins.
HSBC (HSBA.L) — UK-based global banks benefit from higher interest rates, which typically expand net interest margins.
Shell (SHEL.L) — As a major energy producer, Shell benefits from higher global energy prices, including natural gas, which are contributing to UK inflation.
BP (BP.L) — As a major energy producer, BP benefits from higher global energy prices, including natural gas, which are contributing to UK inflation.
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Financial Services (Banking) — Higher interest rates generally lead to improved profitability for banks through wider net interest margins.
Energy Production — Global energy producers benefit from elevated energy prices driven by geopolitical events and supply concerns.
Natural Gas — Prices are elevated due to global forces and the Iran war, benefiting producers and exporters.
Keir Starmer — His position as Labour leader is secured for now, but he is politically weakened, creating ongoing uncertainty.
Rachel Reeves — Her role as Chancellor is tied to Starmer's leadership, which remains under pressure despite the immediate relief.
International Consolidated Airlines Group (IAG.L) — While higher energy prices are a negative, the temporary stability in UK politics might prevent further immediate currency depreciation, offering a mixed short-term outlook.
UK Politics — The immediate crisis of a leadership challenge was averted, but the underlying political instability and pressure on Starmer remain.
UK Retail — While inflation and interest rates are negative, the temporary stability in bond markets might prevent a more severe immediate downturn in consumer confidence.
United Kingdom — Avoided immediate political chaos, but faces persistent high borrowing costs, inflation, and a fragile political landscape.
Sterling — Rose 0.5% against the dollar on temporary relief, but the underlying economic and political challenges suggest continued volatility.
Barratt Developments (BDEV.L) — UK homebuilders face reduced demand and affordability issues due to rising mortgage rates linked to higher gilt yields and Bank of England rate hikes.
Persimmon (PSN.L) — UK homebuilders face reduced demand and affordability issues due to rising mortgage rates linked to higher gilt yields and Bank of England rate hikes.
Tesco (TSCO.L) — UK retailers are negatively impacted by higher inflation and rising interest rates, which reduce consumer disposable income and spending.
National Grid (NG.L) — As a utility, National Grid faces increased financing costs due to higher UK borrowing rates, potentially impacting investment in infrastructure.
easyJet (EZJ.L) — Airlines face increased operating costs from higher jet fuel prices, which are linked to global energy price increases.
UK Housing/Construction — Higher interest rates and reduced consumer confidence lead to a slowdown in housing market activity and new builds.
UK Retail — Reduced consumer disposable income due to inflation and higher borrowing costs negatively impacts sales volumes and profitability.
UK Public Sector — The UK government faces significantly higher borrowing costs on its debt, limiting fiscal flexibility and increasing debt servicing expenses.
Airlines — Higher global energy prices directly translate to increased jet fuel costs, a major operating expense for airlines.
United Kingdom (as a borrower) — The UK government faces significantly higher borrowing costs on its gilts, reflecting a UK-specific risk premium.
UK Consumers — Higher inflation, rising interest rates, and potential economic slowdown reduce purchasing power and increase household debt burdens.
Immediate Gilt Yield Volatility — The immediate relief from Starmer's decision to stay caused a temporary dip in gilt yields, but the underlying political and economic pressures suggest continued short-term volatility. Confidence: High.
Short-term Increased UK Government Borrowing Costs — The UK's 10-, 20-, and 30-year gilt yields remain above 5%, indicating persistently high borrowing costs for the government, which will strain public finances. Confidence: High.
Medium-term Dampened UK Economic Growth — Higher interest rates, elevated inflation, and reduced consumer spending due to increased borrowing costs and energy prices are likely to slow economic activity in the UK. Confidence: Medium.
Medium-term Pressure on UK Housing Market — Rising mortgage rates, driven by higher gilt yields and Bank of England rate hikes, will continue to reduce housing affordability and demand, impacting homebuilders and property values. Confidence: High.
Long-term Constrained UK Fiscal Policy — The gilt market's sensitivity to political uncertainty and fiscal discipline will severely limit any future Labour government's ability to increase spending or relax fiscal rules without triggering another bond sell-off. Confidence: High.
↑ UK 10-Year Gilt Yield — Despite a temporary dip, the underlying trend is upwards due to inflation, BoE rate hikes, and political risk premium.
↑ UK 30-Year Gilt Yield — Remains elevated, reflecting long-term borrowing cost concerns and political uncertainty.
↑ UK CPI (Consumer Price Index) — Expected to remain high due to elevated energy prices and global inflationary pressures, with peak inflation potentially reaching 6.2%.
↑ Bank of England Base Rate — Markets are pricing in two more rate hikes by year-end, indicating a continued upward trend.
↓ UK Consumer Confidence — Higher inflation, rising interest rates, and economic uncertainty are likely to depress consumer sentiment and spending.
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