UK politics in focus: implications for investors

Following the recent local election results, Prime Minister Keir Starmer is struggling to maintain his grip on the Labour Party leadership. Should investors be worried about the potential for more political change? 

Despite the Prime Minister’s insistence on fighting on, speculation is rife about who might replace him should he bow to the pressure. As the situation develops, the party appears poised for a significant shift in direction, with a wide spectrum of potential candidates entering a leadership contest if Starmer’s resignation becomes inevitable. 

What’s been the market reaction?

There are implications for markets, in particular the UK gilt market, where investors are digesting the prospect of looser fiscal policy. Spurred by the potential for a more left-leaning replacement opening the fiscal taps, UK government bonds have fallen notably, with thirty-year gilts yields rising to their highest level since 1998. Meanwhile, the pound has weakened modestly against the dollar, while sterling investment-grade credit has remained broadly stable.

What are the economic implications?

This is another potential shock for a UK economy already grappling with a squeeze on real incomes from higher energy costs and higher mortgage costs as the market had already moved to price in rate hikes from the Bank of England. The latest increase in yields can only partly be attributable to the political turmoil as it has coincided with a renewed rise in crude oil prices. 

However, any prospect of somewhat looser fiscal policy, which in theory could support growth, is in danger of being crowded out by higher rates across the curve. In the event of a change in leadership it will be important that a set of credible fiscal rules are maintained. It might be inconvenient for policy to be constrained by the bond market, but we only have to go back four years to see the consequences of any attempt to circumvent market forces. 

Credit market factors

From a credit perspective, our unconstrained bond team have been adding exposure to sterling investment-grade credit, particularly at the front end of the curve. This is grounded in the view that yields continue to be attractive on a relative basis, supporting strong demand and attractive carry opportunities. 

A change in Prime Minister could have specific implications for certain sectors and issuers in highly regulated areas. A transition towards a more left-leaning government could affect the UK water sector, with issuers such as Thames* potentially experiencing increased pressure to enter special administration.

What is our global rates team doing?

The rates specialist team believe that negativity around UK politics is creating an opportunity in gilts and are considering increasing UK gilt exposure at the longer end of the yield curve. The rates experts’ large language model, used to gauge market sentiment, shows that most investors hold a consensus short gilt view, citing political turmoil and risks to fiscal rules under a more left leaning government. 

The team believe these views are hard to sustain given a lack of specifics related to the arguments (e.g. no specific policies or people), hence are inclined to take the other side.”

Is there a read-across for LDI investors?

LDI investors are typically most focussed on real yields given inflation-linkage in their liabilities. While real yields are either approaching or at highs year-to-date they remain lower than their 2025 peaks. 

We believe that this mix of nominal and real yield asset exposure, larger collateral buffers and improved levels of governance means that LDI investors can maintain a strategic focus through the headlines. Ongoing revisiting of collateral waterfalls remains relevant but some investors may wish to consider whether this is an opportunity for any incremental hedging increase.

 

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an L&G portfolio. The above information does not constitute a recommendation to buy or sell any security.