The pound sterling is heading for its worst week in 18 months as City traders anticipate that UK Prime Minister Keir Starmer could face a leadership challenge from Greater Manchester Mayor Andy Burnham later this year. Sterling dropped by almost three cents, or 2%, during the week to $1.336 on Friday, marking a five-week low. This would be the largest weekly drop against the US dollar since Donald Trump’s election win in early November 2024.
Market Reaction to Political Uncertainty
The pound fell against the dollar every day this week as leadership tensions gripped Westminster. The prospect of Burnham challenging Starmer intensified after the Greater Manchester mayor announced he would run for parliament in the north-west constituency of Makerfield. Kathleen Brooks, research director at XTB, noted: "The pound is weakening this morning after a sharp drop on Thursday, when Andy Burnham threw his hat into the ring. This is a sign that Burnham is the least market-friendly of all the candidates."
UK Government Borrowing Costs Surge
UK government borrowing costs jumped amid a wider sell-off of sovereign debt. Yields on US and German government debt also rose, but the UK saw a steeper increase as a rise in the oil price fuelled inflation worries. The yield on UK 10-year bonds jumped to almost 5.17%, their highest level since 2008, exceeding the 18-year high set earlier in the week. Thirty-year bond yields rose sharply to 5.84%, above the 28-year high reached earlier this week, representing a rise of 19 basis points.
Investor Concerns Over Fiscal Policy
The sell-off in UK bonds reflected concerns in the City that a Burnham premiership might loosen the UK’s fiscal rules and increase borrowing to fund higher spending. Investors recall that in January, Burnham said the UK was "in hock to the bond markets" and trapped in "a low-growth doom-loop," though he has since softened his stance. Neil Wilson, an investor strategist at Saxo UK, said markets would not welcome a left-leaning PM with well-known fiscal views. "Ultimately the bond market is likely to impose fiscal discipline, but it can get messy before that happens," Wilson added.
Political Risk Premium Expected to Persist
Mark Dowding of RBC BlueBay Asset Management told clients that Keir Starmer’s days in Downing Street were "numbered" and that UK financial assets and sterling would likely face an elevated political risk premium for an extended period. It would take weeks before Burnham can challenge Starmer, as he must first win a by-election in an area where Reform UK performed well in local elections and the Green Party could also contest the seat. The sitting MP, Josh Simons, who is stepping down to allow Burnham a route back to Westminster, has a majority of just over 5,000 votes.
Potential Stability Factors
Bill Diviney, head of macro research at ABN Amro, predicts that uncertainty over fiscal policy changes will fuel volatility in gilt markets. However, he noted that Burnham is popular with the public: "Manchester Mayor Andy Burnham is by far the most popular among the general public, and in YouGov polling he is the only major UK politician with a net positive approval rating." Diviney added that retaining Rachel Reeves as chancellor would significantly help, as it would signal continuity and commitment to her fiscal rules that have kept markets relatively stable.
