UK government borrowing costs surged to an 18-year high and the pound weakened significantly on Friday, as Andy Burnham’s decision to contest a by-election injected new uncertainty into the Labour leadership race. The movements in UK markets were more pronounced than in other European nations, with analysts attributing the volatility to investor concerns that a potential Burnham-led government might increase public borrowing.
Market Turmoil and Rising Borrowing Costs
The yield on 10-year UK government bonds, a key indicator of borrowing costs, surpassed 5.14% on Friday, reaching its highest point since 2008. This surge followed a sharp fall in the pound against the dollar, which dropped by 0.3% to approximately $1.337 on Friday, after experiencing a steeper decline late Thursday upon Burnham’s announcement.
Kathleen Brooks, research director at XTB, noted that the pound’s performance indicated Burnham was perceived as less market-friendly compared to other candidates, citing the less severe market reaction to Wes Streeting’s earlier resignation. Over the past week, 10-year gilt yields have hit levels not seen since 2008 on three separate occasions, including the new high reached on Friday.
Long-term borrowing costs also climbed, with the yield on 30-year gilts peaking at a 28-year high of 5.82%. These domestic market pressures occurred against a backdrop of rising global borrowing costs, partly driven by concerns over potential inflation increases linked to surging energy prices amid the ongoing conflict in Iran. Brent crude oil prices saw a significant jump to over $109 a barrel before easing slightly.
Investor Concerns Over Fiscal Policy
Market participants expressed apprehension that a government influenced by Andy Burnham might lead to higher levels of public debt. Burnham himself has previously voiced a desire for the government to move away from being overly reliant on bond markets. In a 2023 interview with the New Statesman, he stated the government had to “get beyond this thing of being in hock to the bond markets.”
AJ Bell investment director Russ Mould commented that while Burnham’s leadership prospects remain uncertain, his past remarks have contributed to the rise in UK borrowing costs and the pound’s decline. Mould suggested that a leadership contest involving Burnham could be lengthy and contentious, thereby prolonging political uncertainty in the UK.
Brooks identified two primary drivers for the market volatility: the prospect of a leftward shift in government policy and the ongoing uncertainty surrounding the Labour party’s leadership. “Overall, UK politics is a mess,” she stated, adding that foreign investors were already showing signs of disengaging from the gilt market.
Mohit Kumar, an economist at Jefferies, echoed these concerns, telling Reuters that the market’s fear was centered on Burnham’s potentially more left-leaning stance and the consequent risk of increased fiscal deficits.
Political Landscape and Next Steps
The negative market reaction was also reflected in UK stock markets, with the FTSE 100 index falling by 1.7% on Friday, although this mirrored similar declines in other European markets. Andy Burnham, currently the Mayor of Greater Manchester, confirmed his intention to run for a parliamentary seat after MP Josh Simons announced his resignation to facilitate Burnham’s candidacy.
Burnham issued a statement on Thursday evening, pledging to “change Labour for the better and make it a party you can believe in again” and to “make politics work properly for people.” However, his path to leadership is not guaranteed. He must first be selected by the local party for the Makerfield constituency and then win the subsequent by-election, a race that analysts predict could be closely contested, potentially involving the Reform UK party.
Future Implications and Market Watch
The immediate future for UK financial markets remains closely tied to the unfolding Labour leadership contest. Investors will be scrutinizing the selection process for Burnham’s candidacy and the outcome of the by-election. Any further signs of fiscal expansionary policies being seriously considered by potential Labour leaders could lead to continued pressure on the pound and gilt yields. Conversely, a more moderate stance or a clear indication of fiscal prudence could help stabilize market sentiment. The potential for significant shifts in government policy, coupled with ongoing global economic uncertainties, suggests that market volatility in the UK is likely to persist in the short to medium term.
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