(Feb 5): A fresh round of political turbulence in the UK rippled across the country’s markets on Thursday, knocking the pound and longer-term bonds.
That drove the gap between two-year and 10-year gilt yields to the widest since 2018, while sterling was the worst-performing currency among peers.
The moves come as doubts build over Prime Minister Keir Starmer’s grasp on power, driving up the political risk premium demanded by investors. Starmer has come under growing pressure over his decision to appoint Peter Mandelson as US ambassador, despite knowing about his connection to disgraced financier Jeffrey Epstein.
“It’s worth keeping a closer eye on the UK with PM Starmer under considerable domestic pressure,” Jim Reid, global head of macro research and thematic strategy at Deutsche Bank AG, wrote in a note. Weakness in gilts reflects concern that “he could be replaced.”
The pound fell as much as 0.4% to near US$1.36, its lowest in nearly two weeks. The 10-year bond yield rose as much as four basis points to 4.59%, pushing the gap over a little-changed two-year rate to 86 basis points.
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Longer-dated debt is more sensitive to political and fiscal risk, while shorter-dated notes tend to be driven primarily by monetary policy. The Bank of England is expected to hold interest rates steady later on Thursday.
“While gilts are watching politics, the front-end will be paying attention to today’s BOE meeting,” said Jamie Searle, a strategist at Citigroup Inc. “There is little need for the Monetary Policy Committee to rush, especially with UK data surprising on the upside of late and weighing on gilts. Yesterday’s rise in political uncertainty adds to the cheapening.”
While longer-dated gilt yields are well below last year’s peaks, rising borrowing costs are another headache on the horizon for Starmer given Labour’s dire standing in the polls and his own record disapproval rating. The party is expected to perform poorly at May’s local elections.
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“This is negative for the currency not simply because political instability is undesirable, but because any change in leadership is likely to be interpreted as fiscally expansionary. Given the UK’s long-standing challenges around debt financing, markets will undoubtedly react negatively to such developments.”
In the past year, markets have been sensitive to any speculation over the future of the prime minister, or his chancellor Rachel Reeves, on the assumption that any replacement would be less committed to the UK’s fiscal rules.
Two weeks ago, gilts sold off after a plausible path appeared to open for Greater Manchester Mayor Andy Burnham to return to Parliament. Burnham, a left-wing rival who has in the past criticised Britain’s deference to the markets, is seen as a potential challenger to the prime minister.
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