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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 0.5 per cent against the euro to €1.146, extending its worst month against the single currency since September, and also slipped versus the dollar.
UK borrowing costs climbed, with the 10-year yield rising 0.03 percentage points to 4.55 per cent, underperforming other European bond markets, as traders braced themselves for more turmoil following the resignation on Sunday of Morgan McSweeney, the prime minister’s most trusted aide.
“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 disgraced financier 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 that the potential downfall of Starmer will 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 pick-up in UK political uncertainty has arrived earlier than we had anticipated . . . and could yet trigger a sharper pound sell-off if there is a leadership challenge,” said Lee Hardman, a currency analyst at MUFG.