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Sterling and gilts weakened on Monday as the leadership crisis threatening Sir Keir Starmer left investors worried over fears of a shift to the left.
The pound fell 0.4 percent against the euro to €1.147, extending last week’s decline, and also slipped against the dollar.
Britain’s borrowing costs rose, with 10-year yields rising 0.05 percentage points to 4.56 percent, underperforming other European bond markets as traders braced themselves for more turmoil following the resignation on Sunday of Morgan McSweeney, the British prime minister’s most trusted aide.
On Monday, Starmer’s communications director, Tim Allen, stepped down.
“International investors just see volatility and want a premium,” said Gordon Shannon, fund manager at Twentyfour Asset Management. He said bond investors were betting that the prime minister was “less likely to go much further” than in May’s regional elections.
McSweeney’s exit was aimed at placating angry Labor MPs and limiting the damage caused by Starmer’s decision to appoint Lord Peter Mandelson as ambassador to Washington in 2024 despite knowledge 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 increasing crisis for the prime minister.
Investors are worried that Starmer’s potential downfall could lead to increased borrowing under the new prime minister. Starmer and Chancellor Rachel Reeves have repeatedly stressed their commitment to the government’s financial rules.
“If we 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 change would “weigh” on the pound and long-term gilts.
A period of relative calm in UK markets risks being jeopardized after Reeves raised taxes in the November budget to ease investor concerns over the scale of government borrowing.
The excess interest rate on 10-year gilts versus German Bunds, which had fallen to a two-year low of 1.55 percentage points in January, has ticked back up to 1.7 percentage points as gilts weakened.
Starmer’s aides warned last week that removing the prime minister could prove “extremely costly to the country” by provoking a market sell-off. Some analysts argue that the possibility of such an outcome could deter MPs from turning against the Prime Minister.
“It would be a bit difficult from a market perspective to do that and it might help to stop the party from doing that right now,” said Derek Halpenny, head of global market research at MUFG. “(Starmer) is definitely on shaky ground.”
