Bond markets are bracing for UK PM Starmer's political rivals to break cover

Bond traders are bracing for more U.K. instability as Prime Minister Keir Starmer is expected to be formally challenged by rivals on Thursday, as he clings to power.

Health Secretary Wes Streeting is expected to resign to launch a leadership bid, while Starmer's former deputy Angela Rayner has reportedly been cleared of deliberate wrongdoing over her tax affairs, boosting her prospects for another potential leadership bid.

Supporters of a popular third contender, Greater Manchester Mayor Andy Burnham, are said to pressing the Labour Party's governing body to extend the timeline for any forthcoming leadership election so that the he can seek the seat in parliament he would need to run for the leadership.

A Labour leadership election can only be triggered if the leader resigns, or if 20% of MPs nominate a challenger, meaning 81 Labour lawmakers would need to back an individual bid.

Competing leadership bids could create division among lawmakers over who to back to replace Starmer, who has vowed to fight on.

While Streeting is seen as more of a continuity candidate, Rayner and Burnham lean more to the left — a factor that has rattled U.K. bond markets and sent borrowing costs higher, with investors fearing a more left-leaning prime minister could herald more borrowing and public spending, and higher debt.

As bond markets opened Thursday morning, the yield on the benchmark 10-year bond — or gilts as they're known in the U.K. — stood at 5.040%, down 3 basis points, while the interest rate on the 30-year gilt hovered around 5.759%.

The government got a rare bit of good news earlier Thursday, with growth data showing the economy expanded 0.6% in the first quarter.

That will be cold comfort to investors, however, with the Iran war, global energy crunch and domestic political crisis combining to make the outlook for the economy, inflation and growth even more confused.

"It's difficult to see this first‑quarter momentum being sustained through the rest of the year with uncertainty rising at home and abroad," Scott Gardner, investment strategist at J.P. Morgan Personal Investing, said via email Thursday.

He added: "The first quarter showed that strong U.K. economic growth is possible but many will be unconvinced that this momentum can be sustained throughout this year. The risk is that the energy price spike following the start of the Iran conflict will persist and lead to a rebound in inflation.

"This would be especially painful for businesses and consumers who have already faced years of higher prices and elevated interest rates."