UK gilt yields retreat from multi-decade highs as political drama mellows, rate hike expectations ease

• The 10-year gilt yield fell to 4.85% and the 30-year to 5.552%, each dropping over 30 basis points in a relief rally as PM Starmer's potential challengers pledged not to loosen fiscal rules
• Political uncertainty had pressured bond markets as nearly 100 Labour MPs called for Starmer's resignation, with leadership favorite Andy Burnham needing to win a June 18 by-election before potentially challenging
• Traders now price one fewer rate hike in 2026, with yields also benefiting from lower oil prices tied to potential U.S.-Iran peace deal and Strait of Hormuz reopening

UK Gilt Yields Retreat as Political Tensions Ease

Key Developments:

UK government bond yields fell to five-week lows on Tuesday, with the benchmark 10-year gilt declining to 4.85% after dropping approximately 30 basis points during a relief rally on Friday. The 30-year gilt also eased by over 30 basis points last week, settling at 5.552% on Tuesday.

Political Context:

Yields had recently spiked to multi-decade highs following disastrous local election results for the governing Labour Party, which triggered pressure on Prime Minister Keir Starmer's leadership. Nearly 100 Labour MPs have called for his resignation, with potential challengers including former Health Secretary Wes Streeting, former deputy Angela Rayner, and Greater Manchester Mayor Andy Burnham—the prediction markets' favorite. Burnham must first win a by-election in Makerfield on June 18 to become an MP before mounting any leadership challenge.

Market Implications:

The political uncertainty had rattled bond markets as investors worried whether a new PM might loosen fiscal rules limiting borrowing and spending. However, yields calmed after potential leadership candidates indicated they would not relax fiscal constraints.

Additional downward pressure came from optimism surrounding a potential US-Iran peace deal and the reopening of the Strait of Hormuz, which would reduce inflationary pressures and lower expectations for future interest rate hikes. Traders now price in one fewer rate hike in 2026 compared to the previous week.

Broader Context:

UK gilts tracked euro zone bonds lower, with German 2-year Bund yields falling over 9 basis points to 2.546% on Monday. Pantheon Macroeconomics noted that gilt investors are looking past recent data releases, with lower oil prices and reduced political uncertainty driving the rally.