UK borrowing costs fall and pound rises as Starmer vows to stay on

UK government bond yields fell and the pound rose on Friday after Prime Minister Keir Starmer said he would remain in office, calming immediate concerns about political succession after Labour suffered heavy losses in local elections.

The yield on the 10-year gilt fell 12 basis points to 4.62 per cent, while sterling gained 0.6 per cent against the dollar to trade above $1.28. The moves reversed some of the sell-off that had built through the week as opinion polls pointed to a poor result for the governing party. Traders said the market was pricing out the risk of a leadership contest that could have paralysed fiscal policy for months.

Starmer said he would not resign after Labour lost hundreds of council seats in England and saw its majority in the Welsh Senedd wiped out. Reform UK, the anti-immigration party led by Donald Trump ally Nigel Farage, emerged as the biggest winner of the night, picking up council seats across swaths of northern England and the Midlands where Labour had held power for decades.

The prime minister’s statement removed what traders described as the “succession premium” that had built into UK assets in recent days. Analysts at Goldman Sachs had warned clients on Thursday that a leadership contest would create an extended period of policy uncertainty at a time when the government faces difficult decisions on spending and taxation ahead of the autumn budget.

Market reaction

The gilt market had priced in a degree of political risk through the week, with the 10-year yield touching 4.82 per cent on Thursday before Friday’s recovery. The two-year yield, more sensitive to monetary policy expectations, fell 9 basis points to 4.31 per cent. The yield curve steepened as long-dated bonds outperformed, a pattern traders said reflected relief that a prolonged political crisis had been averted.

Sterling’s gains were broad-based, with the pound also rising 0.4 per cent against the euro and 0.5 per cent against the yen. The currency had fallen to a six-month low against the dollar on Thursday as exit polls suggested a heavy Labour defeat. Options markets showed a sharp decline in one-month implied volatility after Starmer’s statement, suggesting investors expect a period of relative calm in the weeks ahead.

The FTSE 250, the domestically focused index more sensitive to UK political conditions, rose 1.2 per cent in afternoon trading. The FTSE 100 added 0.6 per cent, supported by the weaker dollar and lower gilt yields that boosted interest-rate-sensitive utility and real estate stocks.

Reform surge

Reform UK gained more than 200 council seats, according to early results, establishing itself as a significant force in local government for the first time. The party won particular strength in areas that voted heavily for Brexit and that had traditionally been Labour strongholds, including Rotherham, Doncaster and Stoke-on-Trent.

Labour also lost ground to the Liberal Democrats in southern England and to the Greens in urban areas such as Bristol and Brighton. The party held onto power in some metropolitan boroughs including Manchester and Liverpool but saw its vote share collapse in smaller towns and rural areas that had swung to Labour in the 2024 general election.

Starmer’s calculation

Speaking outside his Downing Street residence, Starmer acknowledged the result was “deeply disappointing” but said he had a mandate to govern until the next general election. He pointed to the improving economic picture, including lower inflation and faster wage growth, and argued that voters would be reluctant to accept a third prime minister without a national ballot.

Some Labour MPs have privately called for a leadership contest, but no senior figure has publicly challenged Starmer. The party’s internal rules require a formal challenger to trigger a vote, and no potential candidate has yet stepped forward. Allies of the prime minister said they expect the internal pressure to subside once the immediate shock of the results fades and attention shifts to the government’s legislative agenda.

What happens next

Attention now turns to the fiscal outlook, with the Office for Budget Responsibility due to publish its latest forecasts in the coming weeks. The local election results have reduced Labour’s majority in the Senedd, complicating the Welsh government’s ability to pass legislation on planning reform and farm subsidies.

The next general election is not due until 2029, but the scale of Thursday’s defeat has reignited debate about whether Starmer can rebuild the coalition that delivered Labour’s 2024 landslide. For the bond market, the immediate risk of political instability has receded, but the underlying fiscal pressures that drove gilt yields higher through April remain in place. The government’s borrowing requirement for this financial year stands at £297 billion, and investors will watch the OBR’s next forecast for any deterioration in the fiscal headroom against the government’s self-imposed rules.