Bond vigilantes circling as Labour faces election wipeout

Bond vigilantes are circling as fears grow that a lurch to the Left after Labour’s expected wipeout in this week’s local elections could lead to even higher borrowing costs for the Government, companies and households.

The cost of servicing the nation’s debt has shot up since the Iran war erupted over worries that Britain will be the hardest-hit of the world’s major economies by the energy shock.

But UK borrowing costs have also risen far faster than those of its peers since the Middle East conflict started two months ago as concern grows that Prime Minister Sir Keir Starmer faces a leadership contest if Labour is routed.

Traders fear a new leader such as Angela Rayner or Greater Manchester mayor Andy Burnham would loosen fiscal rules that limit borrowing so that they could spend more on welfare to counter the threat from the Green Party and Reform UK.

‘A weak election outcome for Labour, particularly one implying a projected national vote share below the 2009 and 2025 low of 20 per cent, would likely refocus markets on leadership risk and fiscal pressure,’ analysts at investment bank Jefferies said.

‘This would push UK political risk premia higher’, meaning investors would call for a higher interest rate to compensate for holding Government debt.

Bond vigilantes are debt investors who protest against policies such as high public spending by aggressively selling holdings, driving up borrowing costs.

They last struck in the aftermath of the disastrous Liz Truss mini-budget in 2022 when they railed against her £45 billion of unfunded tax cuts and the sidelining of official forecaster, the Office for Budget Responsibility.

At just under 5 per cent, the yield on benchmark ten-year gilts – a key measure of how much it costs the Government to borrow – is more than any other leading economy and is at its highest since the 2008 financial crisis.

But the gap – or spread – between how much the UK and Germany pay to borrow from investors for a decade has risen to almost 200 basis points, or two percentage points, from 158bps when the Iran war erupted.

The spread between UK and US bonds has also widened.

Higher borrowing costs have already fed through to mortgage bills. A typical two-year fixed rate home loan now costs 5.78 per cent, up from 4.83 per cent when the war erupted. Surging bond yields are a headache for Chancellor Rachel Reeves as they push up the cost of servicing Britain’s £2.9 trillion debt pile, eating into the historically low headroom she has left to cushion the country from energy and inflation shocks.

It is also still unclear how Reeves will fill a £28 billion hole in the public finances to fund defence commitments after clobbering firms and families with £70 billion of tax rises. ‘Irresponsible borrowing means more debt and taxes for future generations,’ said Shadow Chancellor Mel Stride.

‘It leaves Britain dangerously exposed to economic shocks and higher interest rates.’

The Bank of England has said interest rates could soar from 3.75 per cent to 5.25 per cent if oil prices – $126 a barrel last week – continue rising.

Polling experts reckon Labour could lose up to three-quarters of its council seats in what would be the worst local election performance for a party in government. It could also lose control of the Welsh Senedd and suffer setbacks in the Scottish Assembly elections.

Burnham has attacked ministers for being ‘in hock to the bond market’, which spooked debt investors last year.

Rayner has avoided attacking the fiscal rules but some of her backers think that they constrain the ability to help voters in a cost-of-living crisis.

HM Treasury said: ‘Our fiscal rules are non-negotiable. They are how we are getting debt and borrowing down while protecting our record £120 billion of investment in public infrastructure with disciplined day-to-day spending.

‘As a result, borrowing has fallen by £20 billion, debt is on a downward path, and the UK’s economic resilience is stronger.’