Market Flash: Labour Leadership Challenge

Kier Starmer’s position as Prime Minister looks increasingly uncertain, following a poor set of election results last week. Several MPs, including a handful of ministers, have called for Starmer to resign. No formal leadership challenge has emerged yet (any challenger requires the formal backing of at least 81 MPs to enter a contest), but one looks increasingly likely.

Market reaction
Although this is mostly a political development, the gilt market has been highly sensitive to political uncertainty since the mini-budget episode in 2022. The 10-year gilt yield has risen by around 0.2% since last week’s elections and is now around 0.8% higher than on the eve of the Iran war, reaching over 5.1%, the highest level since 2008. Bond prices fall as yields rise. While global factors are also at play, recent moves suggest investors are beginning to price in greater political and fiscal uncertainty. The pound has also weakened modestly over the past few days.

For UK equities, at an index level, there should be little impact given how global in nature the UK market is. However, under the surface, companies more sensitive to the UK domestic economy, or sectors which could be targets of a new Labour leader, such as banking, have been negatively impacted. The vast majority of our portfolios’ equity is invested overseas, which has limited the impact.

Leadership contenders
The reason for the heightened volatility in certain markets is that, in addition to investors’ enduring aversion to uncertainty, there is unease amongst gilt investors around the fiscal stance of some of the likely candidates. Generally speaking, the gilt market cares about the government borrowing trajectory, debt sustainability, inflation risk and fiscal credibility. The key distinction between candidates from a market perspective is not political ideology per se, but their perceived stance on government borrowing, fiscal rules and the role of the state. Below is our view on how the gilt market may react to some of the leading contenders, from positive to negative:

• Wes Streeting (Health Secretary) – The gilt market would likely be most comfortable with the Health Secretary, who is viewed as a continuity candidate on fiscal policy and aligned with the more centrist (Blairite) wing of the party.
• Ed Miliband (Energy Secretary and former Labour leader) – There may be slightly more uncertainty here. While not seen as a populist candidate, he is associated with large-scale green investment programmes, which could imply higher government borrowing over time.
• Andy Burnham (Mayor of Manchester) – Seen as supportive of increased public investment and housebuilding. Investor attention has focused on comments suggesting the government “should not be in hock to the bond markets”, as well as potential flexibility around fiscal rules. Such remarks can raise concerns around fiscal credibility, even if overall borrowing levels are not materially higher.
• Angela Rayner (former Deputy Prime Minister) – from the left-wing of the party and is seen as supportive of a higher tax-and-spend approach, which could raise concerns for the gilt market.

As well as the incoming leader, whoever is appointed Chancellor may be just as important to investors. Rachel Reeves has a degree of credibility with the market. Candidates may keep her in place in an effort to placate investors.

Portfolio implications
We are not making any changes to our portfolio based on this development. We continue to believe bonds can perform an important role in a diversified portfolio, given the yields on offer. However, this episode reiterates our preference of a globally diversified approach to achieving government bond exposure rather than concentrating solely on the gilt market, given the increasing volatility and political sensitivity that has characterised the UK bond market in recent years.