Volatile UK politics not exactly a brave new world

Political instability and a potential leadership contest in the UK are adding to the challenges of rising energy prices to drive up government bond yields. We examine the political risks and range of potential outcomes. A large shift in the UK’s fiscal stance is not our base case.

Suffering from very low popularity ratings already, and struggling to recover from a number of recent mis-steps, UK Prime Minister Keir Starmer now faces a highly uncertain political future. Heavy losses for his Labour Party in local elections on 7 May may well prove the final blow to his term in office, as he is increasingly losing the support of Labour Members of Parliament and some of his cabinet ministers.

Political instability, and the potential launch of a protracted leadership contest, has driven up UK government bond yields across maturities, with 30-year Gilts hitting record highs. Investors are concerned that a shift to the left by the Labour Party in its next leader may lead to a much looser fiscal stance, by increasing borrowing and tolerating higher deficits again in the near future. Such an abandonment of fiscal discipline would result in higher yields, as compensation for investors to hold the increasing supply of government bonds.

A further complication is the wide open and potentially protracted race for the next leader, driving further uncertainty and risk premium in Gilts. At the time of writing, no leadership contest has yet been launched, and Keir Starmer could himself run, resulting in a wide range of potential outcomes.

Any new Prime Minister would be subject to the same constraints that the current government is facing

A potential candidate the market sees as likely to increase spending is Andy Burnham, who has previously said the country should not be “in hock” to bond markets. However, Mr Burnham is currently Mayor of Greater Manchester, and would first need to secure a seat in Parliament before running. It is also likely that he would adopt a more measured stance on bond markets and fiscal risks if he were in power. Other potential candidates with a left-leaning stance include former deputy Prime Minister Angela Rayner and Energy Secretary Ed Miliband. Health Secretary Wes Streeting is a more centrist figure, and may stick closer to Labour’s existing policies. His resignation from the cabinet on 14 May may act as a trigger for the leadership contest.

In any case we would not expect a quick resolution to Labour’s leadership conundrum, given the multiple steps involved to elect one. If a contest is held we would expect a new leader to be chosen by September, when Labour holds its annual conference, with Keir Starmer likely staying on as Prime Minister in the intervening period.

Crucially, any new Prime Minister would be subject to the same constraints that the current government is facing. The memory of the short tenure of Prime Minister Liz Truss in 2022, following a ‘mini-Budget’ announcement that unsettled the market with large unfunded tax cuts, could also curb the spending enthusiasm of any new leader. 

related content.

In the newsuk

In the newsukentrepreneurswealth management

Lombard Odier UK CEO warns Rachel Reeves over entrepreneur exodus

March 11, 2026

investment solutions.

learn more

Contrary to some pre-election fears, the current Labour government has also kept a prudent fiscal stance since taking office in 2024, sticking to its fiscal rules and narrowing the government budget deficit from 5.2% to around 4.3% currently. At the same time, the economy’s current account balance has also improved, from a deficit of 3.6% in 2023 to just 2.4% last year. Labour’s fiscal rules include balancing spending with tax revenues by 2029-2030 and reducing public sector debt as a percentage of GDP over the same timeframe.

We therefore think that a radical change in fiscal stance is neither immediate nor particularly likely.

We think that a radical change in fiscal stance is neither immediate nor particularly likely

Political risk is not the main driver of Gilts

Moreover, while we think some degree of fiscal risk repricing may be a natural reaction to recent political events, this has not been the principal driver of rising Gilt yields. These were already on an upward trend since the outset of the Middle East conflict. Thus while the move in Gilts has been particularly pronounced in recent days, directionally it has mirrored recent trends in US, European and Japanese yields, following a repricing of monetary policy expectations across major economies.

In the UK, the sharp increase in energy price inflation makes it highly unlikely that Bank of England (BoE) can cut interest rates further this year, as was broadly anticipated in January. Indeed, market pricing now points to a high risk of rate hikes. This has reversed the strong rally in Gilts that was in place at the start of the year, when a combination of falling inflation, loosening labour market conditions, and soft economic growth were creating the conditions for accelerated monetary policy easing by the BoE.

Gilts were already on an upward trend since the outset of the Middle East conflict

An eventual resolution of the Iran conflict that gradually reopens oil flows through the Strait of Hormuz remains our base case scenario – and would result in a normalisation of UK inflation. Not only would this remove concerns about a higher policy rate in the near term, but together with a loose labour market and slow growth, would set up conditions for BoE easing to resume in 2027. This could reinforce our medium-term constructive view on Gilts.