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Sterling and gilts weakened on Monday as the leadership crisis threatening Sir Keir Starmer rattled investors fearful of a shift to the left.
The pound fell 0.2 per cent against the euro to €1.149, extending last week’s declines, but strengthened against a broadly weaker dollar.
UK borrowing costs climbed, with the 10-year yield rising 0.06 percentage points to 4.57 per cent, underperforming other European bond markets, as traders braced themselves for more turmoil following the resignation on Sunday of Morgan McSweeney, the UK prime minister’s most trusted aide.
On Monday, Tim Allan, Starmer’s director of communications, stepped down.
“International investors just see instability and want a premium,” said Gordon Shannon, a fund manager at TwentyFour Asset Management. Bond investors were betting the prime minister was “less and less likely to get much further” than May’s regional elections, he added.
McSweeney’s exit was designed to placate angry Labour MPs and limit further damage from Starmer’s decision to appoint Lord Peter Mandelson as ambassador to Washington in 2024 despite knowing of his ongoing relationship with child sex offender Jeffrey Epstein.
But the departure of McSweeney, who said he took responsibility for advising on Mandelson’s appointment, leaves Starmer without a key ally during a period of mounting peril for the prime minister.
Investors worry the potential downfall of Starmer could lead to a rise in borrowing under a new prime minister. Starmer and chancellor Rachel Reeves have repeatedly stressed their commitment to the government’s fiscal rules.
“If we do get a change in the premiership, the replacement is likely to be from the left,” said Mohit Kumar, chief European economist at Jefferies, adding that such a political shift would “weigh on” the pound and long-term gilts.
The ructions risk jeopardising a period of relative calm in UK markets since Reeves’ tax-raising November Budget eased investor concerns over the scale of government borrowing.
The additional interest rate on 10-year gilts compared with German Bunds, which had fallen to a two-year low of 1.55 percentage points in January, has ticked back up to 1.7 points as gilts have weakened.
Starmer’s allies warned last week that ousting the prime minister could prove “extremely costly for the country” by igniting a market sell-off. Some analysts argue the potential for such an outcome could keep MPs from moving against the prime minister.
It would “be a bit of a shambles, markets-wise, to do it, and that might help dissuade the party from doing it now,” said Derek Halpenny, head of global markets research at MUFG. “[Starmer is] certainly on shaky ground.”
