By Renae Dyer and Miriam Mukuru
U.K. government-bond yields fell, while sterling rose Friday after Prime Minister Keir Starmer vowed he would stay in his post even as his Labour Party had heavy losses in local elections, according to early results.
Starmer said he wouldn't walk away and "plunge the country into chaos."
Analysts said major losses in U.K. government bonds--known as gilts--and sterling were unlikely unless there were signs that Starmer could step down. Investors are worried that any replacement could favor increased government spending, worsening the already strained public finances.
"This is a serious political setback for Labour, but the market issue is whether this threatens fiscal credibility. So far, it does not," Lale Akoner, global market analyst at eToro, said.
"Gilts could sell off again [causing yields to rise] if leadership pressure becomes credible or Labour pivots toward looser spending," she said.
In midday European trade, sterling rose 0.5% to $1.3616 and the euro fell 0.1% to 0.8641 pounds after Starmer's comments. Yields on 10-year gilts fell four basis points to a two-week low of 4.882%, according to Tradeweb. Gilt yields fell even as yields on their eurozone peers rose.
With many of the districts yet to be counted, early election results showed Labour lost control of eight councils, while the populist Reform UK party made significant headway.
"If the gilt market comes under significant pressure, the pound will weaken," Societe Generale's head of foreign-exchange strategy Kit Juckes said.
However, "the underlying assumption in markets is that the government--whoever runs it--will be wary of the gilt market because higher yields would limit their room for fiscal maneuver," he said. If that assumption is tested, gilt yields could spike and put sterling under pressure, he said.
Opinion polls ahead of the elections had already predicted large losses for Labour.
"Markets are right not to over-react yet," eToro's Akoner said. Labour's leadership has been weakened, but not clearly at risk of changing with the fiscal framework remaining intact, she said.
Concerns about a potential leadership challenge for Starmer had weighed on gilts ahead of the elections. The yield on the 30-year gilt rose to its highest since 1998, at 5.790% earlier this week, LSEG data showed.
Thirty-year gilt yields fell to a two-week low of 5.552% on Friday, according to Tradeweb data. Sterling's reaction to political risks has so far been more limited.
Under Starmer and treasury chief Rachel Reeves, the government has made efforts to reduce the budget deficit, including through tax rises. The government's plans to reduce borrowing could be called into question if Starmer faced new calls to resign.
"It'll be important to watch what Labour [members of Parliament] and cabinet ministers are saying, as gilt markets are focused on whether Starmer will remain in post following the results," Deutsche Bank analysts said in a note.
Ahead of the election, Starmer faced widespread criticism for his handling of the appointment of Peter Mandelson as ambassador to the U.S. Mandelson was forced to step down when the extent of his ties to late sex offender Jeffrey Epstein were revealed.
Potential candidates to replace Starmer if he stepped down include former Deputy Prime Minister Angela Rayner, energy secretary Ed Miliband, Greater Manchester mayor Andy Burnham and health secretary Wes Streeting.
"If markets get a sense that the above chain of events is leading us toward a new more left-leaning prime minister, then we will see some degree of increased political and fiscal risks being priced into both gilts and the pound," Derek Halpenny, MUFG Bank's European head of global markets research, said.
Gilt markets are calm for now but that could change depending on events, deVere Group's Chief Executive Nigel Green said in a note.
"Calm conditions can change very quickly in Britain's bond market," he said.
Write to Renae Dyer at renae.dyer@wsj.com and Miriam Mukuru at miriam.mukuru@wsj.com
(END) Dow Jones Newswires
05-08-26 0701ET
