Gilt yields ease as UK PM Starmer says 'tough' election results won't make him quit

Early results from local council elections pointed to big losses for the U.K.'s ruling Labour Party on Friday, raising questions about Keir Starmer's future as prime minister.

Bond vigilantes have closely watched his fate in recent weeks, and the results are expected to further fuel speculation the prime minister could be deposed by his party.

Vote counts pointed to hundreds of Labour councillors losing their seats and the leadership of many local councils changing hands.

Speaking to reporters as the results continued to emerge on Friday, Starmer labeled the outcome "really tough."

"The voters have sent a message about the pace of change, how they want their lives improved," he said. "Labour was elected to meet those challenges, and I'm not going to walk away … and plunge the country into chaos. It was a five-year term I was elected to do, [and] I intend to see that through."

Yields on benchmark 10-year U.K. government bonds, known as gilts, were almost 6 basis points lower at 4.888% by 10:38 a.m. in London on Friday, moving downward in response to Starmer's insistence that he would not step down from his post.

The predicted election result will not affect the composition of parliament in Westminster or change who is in government, but reflects souring sentiment on Starmer's leadership among the electorate.

Labour and its main opposition party, the Conservatives, are widely expected to suffer heavy losses, while right-wing Reform UK and the left-wing Green party are anticipated to make major gains.

Backbench Labour MPs — parliamentarians without a position in government — are reportedly planning to blame looming losses on the prime minister and demand his resignation.

In a Friday morning note, a team of analysts at Deutsche Bank led by Jim Reid said that the U.K. would be in focus for investors as the outcome of the election becomes clearer.

"Today, it'll be important to watch what Labour MPs and cabinet ministers are saying, as gilt markets are focused on whether PM Keir Starmer will remain in post following the results," they said.

"That's because of expectations that a new Labour leader might ease the fiscal rules and raise gilt issuance, so when Starmer's position has come into question, that's coincided with selloffs for gilts."

The full result of the election will not be known until Saturday afternoon, by which time all the councils that held elections are expected to have announced their results. The Scottish parliament and Welsh Senedd, which oversee their respective devolved governments, are expected to announce full results by Friday evening.

Starmer and his finance minister, Rachel Reeves, have been battling discontent over fiscal policy within their own ranks, while welfare reforms and the appointment of Peter Mandelson — an associate of the late sex offender Jeffrey Epstein — as U.S. ambassador, have further damaged inter-party relations.

Health Minister Wes Streeting, former Deputy Prime Minister Angela Rayner and Greater Manchester Mayor Andy Burnham are reported to be among the top contenders to replace Starmer. Rayner and Burnham — who is currently ineligible to stand as prime minister because he lacks a seat in parliament — are broadly considered more left-leaning than Starmer.

But markets have been supportive of Starmer and Reeves retaining their positions relative to potential alternatives, with U.K. bonds selling off in previous bouts of uncertainty over their political futures.

Last July, yields on U.K. government bonds — known as gilts — surged after Reeves was seen crying in parliament, amid reports that her role in Starmer's cabinet was in jeopardy. It came after the government U-turned on her proposed welfare cuts following a rebellion from Labour politicians.

U.K. 10-year gilt

Bond yields and prices move in opposite directions.

Gilt yields were lower across the curve on Friday, with the yield on the 2-year gilt shedding 5 basis points while those on 20- and 30-year gilts lost 9 and 8 basis points, respectively. Longer-term gilt yields also surged to multi-decade highs earlier this week, with 30-year borrowing costs touching their highest level since 1998.

U.K. 30-year gilt

The U.K. already has the highest government borrowing costs in the G7, with its 10-, 20- and 30-year debt commanding yields above the critical 5% threshold. Yields effectively represent the interest paid by the government to investors who hold its debt.

Freya Beamish, chief economist at TS Lombard, told CNBC's "Squawk Box Europe" on Friday that "politics really do matter for yields," adding that it would be difficult for the Labour party to shift to "growth budget" policies against the backdrop of rising prices and economic constraints.

"The gilt market certainly would react poorly to 'let's spend our way out of this' without dealing with any of the sort of the wastage there, or 'let's cut taxes,' which would be a sort of a growth policy, but you can't just go for the growth policy without dealing with the... wastage in the spending side of the of the ledger," she said.

"And we do know there must be some sort of wastage there — even as a percentage of GDP, many departments and many forms of government spending are higher now than they were pre-Covid."

Nigel Green, CEO of financial consultancy deVere Group, told CNBC early Friday morning that gilt markets "pay extremely close attention to political authority, particularly when governments are already facing difficult fiscal conditions."

"Rachel Reeves is completely tied politically to Starmer on the economy," he said. "If gilt yields remain under pressure while Labour absorbs heavy electoral losses, investors may begin concluding the government is becoming politically weakened as well as fiscally constrained."

Jonathon Marchant, a fund manager at U.K.-based Mattioli Woods, told CNBC that the early indication was that "it is likely to be tough day for Kier Starmer."

"Given the ratcheting up of tensions in the Middle East overnight and the associated impact on oil and inflation, disentangling the market's perception of local elections is challenging," he said. "Gilt yields fell slightly on open, with the market appearing to have priced in a marginally worse outcome for Labour in the run up to the local elections."

Marchant noted that Starmer has "remained resolute in recent weeks and is likely to want to fight on."

"Indeed, we could see the pace of attempted policy change accelerate," he told CNBC. "However, for markets the question is: 'in which direction?' Tacking further to the left is likely to appease back benchers and block internal opposition and while this would be more favorable than a leadership change, it is not something markets are likely to welcome."