By Renae Dyer
Yields on U.K. government bonds jumped to highs not seen in over a decade and sterling fell sharply Friday as investors worried that a successful challenge to Prime Minister Keir Starmer could lead to higher public spending.
Yields on the 30-year U.K. government bonds, known as gilts, rose to a peak of 5.820%, their highest since 1998, according to Tradeweb. Meanwhile, yields on 10-year gilts rose 14 basis points to 5.147% on Friday, their highest level since 2008.
Sterling fell to five-week lows of $1.3325 and 0.8727 per euro.
Labour lawmaker Josh Simons on Thursday said he would resign to make way for Greater Manchester Mayor Andy Burnham to return to parliament and challenge Starmer. Burnham would need to win an election in Simons's district, where the populist Reform U.K. party performed strongly in recent local elections.
"Market's fear is that Burnham would be more left-leaning, and we could see further increase in deficits," Jefferies economist Mohit Kumar said in a note.
If Labour lawmakers back Burnham to challenge Starmer, then political uncertainty could persist for much longer compared to other potential candidates who already have seats in parliament, Derek Halpenny, MUFG Bank's European head of global markets research, said.
"This will not be a favorable backdrop for the gilt market or the pound."
Investors are concerned that a more left-leaning candidate such as Burnham could favor increased government spending, which would increase borrowing without tax rises of a similar size. Burnham last year said the U.K. government shouldn't be "in hock" to the bond markets.
"Moreover, Burnham suggested last week that defense spending could be considered outside the fiscal rules, which added to speculation about more gilt issuance under a Burnham premiership," Deutsche Bank analysts said in a note.
A "Burnham premium" is weighing heavily on U.K. government bonds, sending yields higher, and this trend is likely to continue until markets get further clarity, strategists at TD Securities said in a note.
There are a number of other potential candidates to succeed Starmer. Wes Streeting, who stepped down as health secretary on Thursday and is seen as a centrist, might enter a contest, as may former Deputy Prime Minister Angela Rayner.
Labour's ruling National Executive Committee will need to decide if Burnham is allowed to run in the special election in the Makerfield constituency. The committee blocked him from standing in the Gorton and Denton special election earlier this year. It is also uncertain whether Burnham would win the Makerfield seat.
"Nevertheless, the noose around Starmer's neck seems to be slowly tightening," Commerzbank foreign exchange analyst Michael Pfister said in a note.
"The Prime Minister appears severely weakened, and it is questionable whether he can remain in office for much longer."
Starmer has come under pressure to resign after Labour's bruising defeat in last week's local elections.
Under Starmer and U.K. treasury chief Rachel Reeves, the government has made efforts to improve the public finances and investors worry that any new leader would take a different approach to fiscal policy.
Any potential candidate would need the support of 81 Labour lawmakers to trigger a leadership contest under the party's rules.
"U.K. political risk is set to stay live via candidate selection, polling, party dynamics and any clearer timetable for a potential transition away from Starmer," said Patrick Munnelly, strategist at Tickmill Group in a note.
Write to Renae Dyer at renae.dyer@wsj.com
(END) Dow Jones Newswires
05-15-26 0722ET
