Rising Concerns Over the Pound Amid Political Instability
Currency traders are increasingly betting against the British pound as political gridlock continues to affect the government. Recent data indicates a growing sense of unease among investors, with speculation about a potential shift to the left following an extended leadership challenge to Sir Keir Starmer.
Sterling has been on a downward trend for five consecutive days, reaching $1.33 after Manchester mayor Andy Burnham was given the opportunity to run for Parliament. This development is seen as a step towards challenging the Prime Minister, raising concerns about the future direction of the country.
A weaker pound can have significant implications for consumers. It leads to more expensive foreign holidays and higher costs for imported goods such as fuel, food, and electrical items. Additionally, it could result in increased mortgage rates if interest rates are raised to support the currency.
There are growing fears that the fiscal rules limiting borrowing might be relaxed to fund more welfare spending. This has already caused a surge in borrowing costs since Labour’s defeat in this month’s local elections. The yield on the government’s benchmark ten-year gilts has climbed above 5%, reaching its highest level since the 2008 financial crisis. The prospect of Burnham taking over as Prime Minister has unsettled investors.
Burnham has previously stated that Britain should not be “in hock” to the bond markets. However, rising yields, which occur when gilt prices fall, are causing concern. The sell-off in gilts is spilling over into currency markets, posing a risk of a full-blown run on the pound.
Traders have been negative on the pound for almost a year. However, the latest data from the Commodity Futures Trading Commission shows that up to 64,000 net bets have been placed against sterling, worth nearly £4 billion – the highest in two months. While the pound has maintained its value, the surge in government borrowing costs and renewed political instability are causing alarm among traders.
Neil Wilson of Saxo Bank commented, “Politics is hammering sentiment towards sterling.” Mark Dowding of RBC BlueBay Asset Management is also moving away from the pound, stating, “UK financial assets and sterling seem likely to be subjected to an elevated political risk premium for an extended period.”
Britain relies heavily on foreign investors to manage its finances, with over a quarter of its national debt held abroad. These investors lend to the government to cover the gap between what it spends and what it collects in taxes. However, the UK also runs a trade deficit, where imports exceed exports, putting additional downward pressure on the pound because the UK must sell sterling to buy foreign currency to pay for imported goods and services.
“We are reliant on the kindness of strangers, so any sell-off in gilts would be likely to take the pound lower,” said Jane Foley of Rabobank.
The last time bonds and sterling fell together was after the disastrous Liz Truss mini-Budget in 2022, when hidden borrowing in parts of the pension system was exposed, leading to a Bank of England bailout. Although current government borrowing costs are higher now, they have not risen as quickly as four years ago, and the pound is well above the near-parity it briefly reached against the dollar at that time.
The bond sell-off has also impacted the value of millions of workplace pensions, particularly for those nearing retirement who are automatically moved into ‘lifestyle’ funds that primarily invest in bonds and other fixed income investments.
“If you own bonds in your pension or elsewhere, you will find their value has fallen significantly – by 20 per cent in the past few days for some gilts – and there’s no upside,” said industry expert Henry Tapper.
