The commitment of Andy Burnham's government to existing fiscal rules will determine whether UK borrowing costs fall or rise further this year, according to UBS, which believes investors are waiting for clear signals ahead of the Autumn Budget.
The bank estimates that domestic political uncertainty has added around 20 basis points to 10-year gilt yields since February, but argues that this premium above other government bond yields could unwind if ministers maintain their existing fiscal framework.
UBS said any decision to loosen those rules to fund additional spending or tax cuts could have the opposite effect, and send Gilt yields up even higher.
"We believe Burnham's earlier comments about complying with the current fiscal rules have capped the upside on UK gilts," UBS said. If the rules are changed, "the risk premium could rise materially".
Government bond yields in Europe and across the Atlantic have risen this year, with a major factor being worries about the inflationary effects of the Iran war.
Indeed, UBS stressed that politics is only one factor driving yields for UK gilts, with some element of investors reassessing the outlook for Bank of England interest rates following the escalation of conflict in the Middle East.
The bank said the domestic risk premium is higher than it has been for roughly 83% of the time in the historical data, leaving gilts particularly sensitive to further policy announcements over the coming days.
