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The pound and gilts came under pressure on Thursday as investors worried about the risks to UK assets from the mounting leadership speculation surrounding Sir Keir Starmer.
UK borrowing costs rose to their highest since November, with the 10-year yield up 0.03 percentage points at 4.58 per cent, as the prime minister faced rising anger from his party over the fallout from the Jeffrey Epstein scandal and his decision to appoint Lord Peter Mandelson as the US ambassador in 2024.
The pound was down 0.5 per cent against the dollar at $1.359, and down 0.3 per cent against the euro.
The sell-off threatens to undermine a period of relative calm in the gilt market since chancellor Rachel Reeves’ tax-raising November Budget eased investor concerns over the scale of government borrowing.
“We had thought that political risks would remain contained until later this year, but the revelations with respect to Lord Mandelson may be the final nail in the coffin for a leader who has long been unpopular within his own party,” said Mark Dowding, chief investment officer for fixed income at RBC BlueBay Asset Management.
In light of this growing political risk, the asset manager had added to a pre-existing bet that the pound would weaken against the euro, Dowding added.
Investors worry about a rise in borrowing under any successor to Starmer. The prime minister and Reeves have repeatedly stressed their commitment to the government’s self-imposed borrowing limits. One potential leadership candidate, Andy Burnham, has said the UK should not be “in hock” to bond markets.
Investors had expected this risk might flare up after regional elections in May, but the backlash over Starmer’s decision to appoint Mandelson has reignited concerns over unstable politics.
“A potential challenge to Starmer’s position as prime minister from the left of the Labour Party has long seemed to us the biggest risk facing UK assets in the first half of this year,” said Seb Barker, chief market strategist at hedge fund firm Marshall Wace, adding that such a risk remains “poorly priced” by the market.
Gordon Shannon, a fund manager at TwentyFour Asset Management, said the reaction “so far appears tempered by hopes that any replacement would come from the less market-hostile wing of the party”.
Sterling last month hit its highest against the dollar since 2021, helped by a weakening in the greenback sparked by the political crisis over Greenland and a broadly positive reception by investors to the Budget.
That rally prompted some investors to bet that the currency had become overvalued, given the risk of a challenge to Starmer.
“We thought that UK political risk was no longer sufficiently priced in. [That risk] has materialised quicker than we expected,” said Mike Riddell, fund manager at Fidelity International, who is using derivatives to bet against the pound.