UK long-term borrowing costs have surged to their highest level in 28 years as investors brace for a potential challenge to Sir Keir Starmer’s premiership after what is widely expected to be a poor showing by Labour in the local elections this week.
The yield on the 30-year government bond climbed to 5.772 per cent, its highest level since 1998. The benchmark ten-year government bond rose by 0.13 percentage points to over 5.1 per cent on Tuesday, trading at levels last seen during the 2008 global financial crisis. The yield on a bond moves inversely to its price.
The Labour Party is expected to lose thousands of seats to Nigel Farage’s Reform UK and the Green Party in the elections on Thursday.
Investors are concerned that Starmer will face a leadership battle if the results are as bad as forecast, with potential challengers from the left wing of the party, including the Manchester mayor Andy Burnham and the former deputy prime minister Angela Rayner, leading to even heavier government borrowing and spending.
Thomas Pugh, chief economist at RSM UK, said in a note to clients: “The prospect of a leadership challenge is yet another source of uncertainty for businesses and households that could prompt them to put off investment and spending.
“Financial markets would likely respond by pushing gilt yields higher, as any successor is likely to be more spendthrift than Starmer and [Rachel] Reeves, raising borrowing costs across the economy.”
Analysts at Nomura, the Japanese investment bank, said: “Low turnout … and voters more willing to register a protest at local vs national elections make this set of elections particularly risky for Labour and the PM in particular.”
Angela Rayner Karl Black/Alamy
Britain’s borrowing costs are the highest in the G7 and have risen rapidly since the Gulf conflict started over two months ago. The country is more exposed to the war’s inflationary fallout due to its dependence on imported natural gas, the price of which has increased sharply.
London’s FTSE 100 stock index fell by more than 1 per cent on Tuesday and the pound edged higher against the dollar to $1.35.
Investors also sold off UK government debt on mounting expectations that the Bank of England will be forced to increase interest rates this year to deal with the inflationary consequences of the war.
Last week the central bank warned that it may have to increase borrowing costs to as high as 5.25 per cent if oil and gas prices rise substantially and stay higher for some time. In such a “worst-case scenario”, the Bank of England projected that inflation would exceed 6 per cent, up from 3.3 per cent presently. Rates were left unchanged at 3.75 per cent last week.
Several City investment banks and researchers have changed their forecasts for the UK economy to incorporate interest rate rises after last week’s meeting of the Bank’s monetary policy committee. Nomura, BNP Paribas and Pantheon Macroeconomics all said rates would rise this year. Before the outbreak of the Gulf conflict, the Bank was expected to lower rates twice in 2026.
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Bond markets are usually preoccupied with changes in interest-rate expectations, but have become increasingly fixated on political developments in the UK because of the high likelihood that Starmer will be forced into a more generous fiscal policy to appease the Labour left and solidify his leadership, or may be replaced entirely by a candidate from that wing of the party.
Either outcome could lead to greater borrowing when the public finances are already stretched. The debt-to-GDP ratio is nearly 100 per cent and debt interest spending is projected to exceed £100 billion annually until at least 2031.
Separately on Tuesday, the Bank of England estimated it would book a £125 billion cumulative loss on its bond-buying programme, up from its previous projection of £115 billion, which will be paid for by the taxpayer due to an indemnity agreement between the central bank and the Treasury.