Rates Spark: Gilts don’t like political uncertainty
The desk observes that UK gilt yields are likely to carry a significant risk premium as political uncertainty prevails, particularly with Andy Burnham viewed as a likely successor to Keir Starmer as PM. This potential shift adds to the macroeconomic headwinds already influenced by signals from the ECB regarding growth focus (per the full note source). With no high-impact calendar events on the horizon, traders should remain alert for market reactions to political developments in the UK and statements from Christine Lagarde, as sentiment around ECB policies may also shift attention in the forex space.
What the desk is arguing
The desk argues that UK gilt yields will likely remain elevated due to political uncertainty surrounding the possibility of a leadership change in the UK government. As per the full note from ing-think, the anticipated rise of Andy Burnham may add a risk premium to gilts, supported by recent macroeconomic data that suggests increased focus on growth dynamics from the ECB.
Current UK political dynamics, against a backdrop of mixed messages from the ECB, reinforce the importance of sentiment around growth and yields. The looming uncertainty could foster a cautious approach, leading participants to price in the risk of further rate hikes.
Where it sits in our coverage
For GBP, our consensus target stands at 1.3500 with a narrow range between 1.2400 and 1.3800. Specific Dec-26 targets include citi at 1.2400, deutschebank at 1.4200, and mufg at 1.4000.
This perspective aligns closely with the mid-range of the consensus, indicating that the desk's assessment incorporates macroeconomic signals whilst accounting for the emerging political landscape shaping expectations around the UK yield curve.
How other firms see it
Several firms, including deutschebank and mufg, share a similarly cautious outlook regarding GBP, with targets around the consensus. Meanwhile, citi offers a more bearish view with a lower Dec-26 target of 1.2400.
The trajectory for GBP/USD is expected to be influenced by ongoing commentary from the UK’s monetary authorities and fluctuations in sentiment towards the ECB's policy adjustments, particularly in light of recent geopolitical developments.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01UK gilt yields are projected to retain a risk premium due to political uncertainties around the new PM prospects.
- 02Christine Lagarde's signals from the ECB have shifted towards a growth focus which could impact rate expectations.
- 03With no immediate calendar events pressuring market dynamics, traders should remain nimble to political updates.
- 04The EUR/USD and GBP/USD pairs should be closely monitored as they reflect risk sentiments from both the ECB and UK political shifts.
Market implications
Keep an eye on GBP/USD levels around 1.3500, with potential volatility if Andrew Burnham's leadership prospects garner further attention. Maintain awareness of evolving ECB sentiments as these will directly impact risk appetite in the forex market.
Risks to this view
A decisive shift in the political landscape of the UK or a more hawkish pivot from the ECB could invalidate the current thesis. Should market sentiment shift towards optimism on growth without geopolitical headwinds, yields and the associated risk premium may compress.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2026 |
|---|---|---|
Scotiabank | Bearish | 1.1200 |
Bank of America | Bearish | 1.1200 |
ANZ | Bearish | 1.1400 |
Articles Rates Spark: Gilts don’t like political uncertainty 07:45 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Mixed signals from Christine Lagarde are suggesting a more balanced view from the ECB, potentially with more focus on growth after new PMI data. Meanwhile, UK gilt yields are likely to keep a material risk premium as we head into a period of economic policy uncertainty Benjamin Schroeder and Michiel Tukker Andy Burnham is likely to replace Starmer as PM, and the associated political uncertainty could keep gilt yields higher A more balanced ECB view could increase focus on growth dynamics The market is staying optimistic about the developments in the Middle East, having brushed away the somewhat rough start to the negotiations over the weekend. Brent oil is stabilising below US$80/bbl.
Had these developments come two weeks earlier, it is unclear whether the ECB would still have hiked. However, once it did, it had to commit to its action. One might be tempted to put down the hawkish comments as ex-post justification and defence of past action rather than any guidance of what is still in store.
Lagarde’s latest comments also seem to tone down the relevance of her assessment that there had already been signs of second-round inflation effects. To the EU parliament, she said there was no need for a more forceful ECB response to the Iran war, although that is not out of line with the "measured adjustment" she mentioned in the case of a "sizeable but not-too-persistent overshoot" of inflation. That said, there is still a lot of uncertainty around the geopolitical outlook.
We would even go as far as to say the market – as reflected in oil prices – might be a bit too optimistic about how fast disruptions in the energy flow can be cleared. That might also explain why the rates market, at least, is still holding on to the notion of another hike from the ECB, even if now only fully discounted by year-end rather than already by October. The easing of tensions might allow for a more balanced assessment of inflation versus growth, though already now, meaning the eurozone flash PMIs as a more contemporaneous barometer of the state of the economy, could be more influential this time.
That is, if we were to get a larger surprise to the downside. Currently, the market is actually looking for a slight improvement coming from the services side, though still seeing the sector in contractionary territory. Political uncertainty adds to risk premium in gilt yields Starmer’s resignation is now official, but we’re still in guessing mode about Burnham’s concrete plans for the economy.
Burnham becoming the next prime minister is not confirmed yet, but a lack of competition and polling websites suggests an almost certain chance. The inflation story remains the primary focus of markets, but the additional political uncertainty can add to the risk premium. In theory, Burnham pursuing an expansionary fiscal policy could pose further upward pressure on rates.
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