THE INTEREST rate on 30-year UK government bonds rose to its highest level since 1998 on Tuesday, as investors reacted to rising energy prices linked to the West Asia war and political uncertainty ahead of Britain's local elections.

The yield on 30-year gilts climbed above 5.77 per cent as UK traders returned after Monday's public holiday and caught up with moves in global bond markets.

Britain's borrowing costs have risen sharply since the Iran war began, with investors concerned about the country's exposure to higher energy prices and pressure on public finances.

Markets are also focused on Thursday's local elections, where the ruling Labour Party is expected to suffer losses to Reform and the Green Party across English local authorities and the Scottish and Welsh parliaments.

Investors are watching whether the scale of Labour's losses could trigger questions over prime minister Keir Starmer's leadership and increase pressure for policy changes.

"There is some catch-up in the UK market after yesterday's holiday," Jane Foley, Rabobank's head of foreign exchange strategy, told AFP.

"While the move in the... market appears to be primarily driven by fears of rising hostilities in the US/Iran war, the UK is facing domestic political risks in the form of this week's election."

Foley said that "betting odds strongly suggest that PM Starmer will be replaced this year.

"Odds also favour a candidate from the left wing of the party which could create headwinds for UK asset markets," she added.

Expectations of a possible leadership challenge have increased as Starmer's popularity has fallen in opinion polls.

Speculation over his future also grew after the controversy surrounding his appointment of Peter Mandelson as U.S. ambassador. Mandelson was sacked last September after emails revealed his links with the late convicted U.S. sex offender Jeffrey Epstein.

Betting platform Polymarket showed less than a 10 per cent chance of Starmer leaving immediately, but nearly a 70 per cent chance of him being replaced by the end of the year.

Investors said the market reaction after the local elections would depend on the scale of Labour's losses.

Royal London Asset Management head of rates and cash Craig Inches said a major selloff in gilts would require a "catastrophic" result because much of the negative outlook had already been priced into the market.

He added that a better-than-expected result for Labour could trigger a relief rally.

Inflation concerns linked to the Iran war have already pushed benchmark 10-year gilt yields up around 70 basis points to 4.94 per cent.

Britain's 30-year bond yields touched their highest level since 1998 earlier this week.

Investors are concerned Starmer could come under pressure to move Labour policy further to the left or eventually be replaced by a leader favouring higher spending.

Colin Finlayson, fund manager at Aegon Asset Management, said almost anyone replacing Starmer would be viewed as less favourable for markets, while a shift to the left would mean weaker fiscal discipline.

Investors are also watching Chancellor Rachel Reeves, whose commitment to borrowing rules has reassured markets.

Finlayson said gilt yields could rise further if there were signs Reeves might be replaced.

Among possible future Labour leaders, investors said former deputy prime minister Angela Rayner and Manchester mayor Andy Burnham would likely be viewed negatively by gilt markets. Health secretary Wes Streeting was seen as less of a concern.

Burnham said last year Britain needed to move beyond "being in hock to the bond markets", drawing criticism from investors.

Speaking to Bloomberg last week, Burnham said defence spending could be considered outside fiscal rules, adding that the rules should not block defence spending.

However, Burnham would need to return to parliament to launch a leadership bid, while Rayner remains under investigation over her tax affairs.

Franklin Templeton head of European fixed income David Zahn said politics would continue to keep UK bonds volatile, but yields above 5.25 per cent on 10-year gilts would present a buying opportunity.

The Iran war has also added pressure to Britain's public finances through higher borrowing costs and expectations of slower economic growth.

Deutsche Bank estimates the fiscal buffer available to Reeves under the government's borrowing rules has fallen to around £10 billion from nearly £24 billion announced in March, before the impact of the Iran war.

The bank said this pointed to another difficult budget in the autumn.

Rising bond yields and changing expectations from interest rate cuts to possible rate hikes have also made the gilt market more fragile, although some investors see the recent rise in yields as a buying opportunity.

(With inputs from agencies)