Andy Burnham wins special election, eyes Labour leadership challenge

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Andy Burnham has won a special election to the British parliament, clearing a path for him to challenge Prime Minister Keir Starmer for the party leadership.

Burnham, Labour's former Greater Manchester mayor, defeated the Reform U.K. party by more than 9,000 votes, taking nearly 55% of the vote, in the election in Makerfield, in north-west England.

Burnham could now trigger a leadership challenge to Starmer as soon as next week, once he is formally sworn in as a Member of Parliament. He will require the support of at least 81 Labour lawmakers.

A prominent figure on the party's left often dubbed Labour's "King in the North," Burnham said in his victory speech that Makerfield was "not a stepping stone" but a "touchstone," promising to put neglected communities at the center of his politics.

In his victory acceptance speech, Burnham appeared to lay the groundwork for a leadership bid.

He said the win provides the "chance to build a new politics, based on unity and hope", and an opportunity to turn "away from the path that takes us to a divided, dark politics of the kind we see in the United States," adding "we must put the country back on the right path."

U.K. fiscal discipline in the spotlight

While Burnham's victory had largely been expected, the win raises several immediate questions for markets, said Kallum Pickering, chief economist at Peel Hunt.

Crucially, markets will be watching whether a Burnham government would stick to Labour's existing fiscal rules and if his policy agenda risks adding to inflationary pressures.

It comes as official data shows an unexpected rise in U.K. public borrowing. The Office for Budget Responsibility revealed on Friday that the U.K.'s budget deficit was £23.3 billion ($30.8 billion) in May, the highest level for that month in six years and far above the £18.9 billion forecast by economists.

Burnham last month moved to placate investors, rowing back on previous comments in which he suggested the U.K. was "in hock to the bond markets."

Pickering said he did not expect Burnham to signal a break with the current framework on borrowing and debt — but he warned that investors may still demand extra compensation for inflation risk in U.K. government bonds.

"I'm expecting to see some inflation premium," Pickering told CNBC's "Europe Early Edition" on Friday, pointing to potential pressure across both short- and long-dated government bonds, known as Gilts.

The yield on 10-year Gilts , the benchmark for U.K. government borrowing, jumped more than 6 basis points in early trade Friday to 4.8162%. Yields on 2-year and 30-year Gilts also moved higher.

Matthew Ryan, head of market strategy at Ebury, said markets are underestimating the risk of Burnham testing the U.K.'s fiscal rules on government spending, income tax rates and borrowing.

"There's very little fiscal headroom, there's very little wiggle room for the government at the moment," he told CNBC's "Squawk Box Europe", noting that the Autumn Budget will be the next big test for the Labour government. "We do see some more downside on U.K. assets."

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Pickering added: "It's right that the market will pay attention to the relationship between bond yields and sterling. We've had this unfortunately all-too-familiar situation in the U.K. where bad policies push up interest rates and push down sterling. That's the thing to watch."

The timeline of any leadership challenge could also prove critical.

An orderly transition could limit market disruption if senior Labour figures conclude Starmer no longer commands support. But Pickering said a drawn-out contest between Starmer and Burnham may leave investors waiting for greater clarity on tax, spending and borrowing measures.

Pickering said a bigger question centers around who would serve as finance minister in a Burnham cabinet and how that would ultimately shape economic policy.

"The uncertainty for me is not over what happens next in Number 10, it's what happens next door in Number 11," Pickering said, referring to the traditional residence of Britain's chancellor of the exchequer.