Political turmoil surrounding Downing Street triggered sharp movements across British financial markets on Thursday, sending the pound lower and pushing Government borrowing costs higher.Sterling fell to become the worst performing major currency, while the spread between two year and 10-year gilt yields widened to its largest gap since 2018.The market reaction comes amid growing investor concern over the stability of the Government and the Prime Minister’s political position.Investors are demanding a higher premium to hold longer dated UK Government debt as uncertainty grows around the political outlook.
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The latest volatility marks another period of political instability affecting UK financial assets as investors monitor developments in Westminster.Longer term Government bonds experienced the most significant selling pressure, while shorter dated debt remained comparatively stable.The benchmark 10 year gilt yield rose by as much as four basis points to 4.59 per cent at the start of trading on Thursday.This pushed the gap between two year and 10 year borrowing costs to 86 basis points, the widest level recorded in nearly eight years.At the same time, sterling fell by as much as 0.4 per cent to around $1.36, its weakest level in almost two weeks.The widening gap between short and long term borrowing costs reflects different market drivers across the yield curve.Longer dated gilts are typically more sensitive to political and fiscal risk, while shorter term debt tends to react more directly to interest rate expectations.The Bank of England is widely expected to hold interest rates at current levels when it announces its latest decision later on Thursday.Political pressure on the Prime Minister has increased following his decision to appoint Peter Mandelson as the UK’s ambassador to Washington.The appointment proceeded despite links between Lord Mandelson and disgraced financier Jeffrey Epstein becoming part of the political debate.The situation has increased scrutiny of the Prime Minister and raised questions among investors about political stability.LATEST DEVELOPMENTSCouncils threatened with insolvency as special needs spending blows £14billion hole in local budgetsPension hack could create ‘savings buffer’ for millions of Britons unable to workFtse 100 skyrockets to ANOTHER record despite ‘spooked market’ after AI sell-offMarket participants have responded by pricing in a higher political risk premium for holding UK Government debt.Some investors are assessing the possibility of leadership change, which could introduce additional uncertainty into financial markets.Jim Reid, global head of macro research and thematic strategy at Deutsche Bank, said: “It is worth keeping a closer eye on the UK with PM Starmer under considerable domestic pressure,” adding that gilt weakness reflects concern that “he could be replaced”.Jamie Searle, strategist at Citigroup, said: “Yesterday’s rise in political uncertainty adds to the cheapening” of Government bonds.Skylar Montgomery Koning, strategist at Bloomberg, said: “This is negative for the currency not simply because political instability is undesirable, but because any change in leadership is likely to be interpreted as fiscally expansionary.”Mr Koning added: “Given the UK’s long standing challenges around debt financing, markets will undoubtedly react negatively to such developments.”Over the past year, markets have shown sensitivity to speculation about the future of the Prime Minister and Chancellor Rachel Reeves.Some investors have suggested that any leadership change could alter the Government’s commitment to existing fiscal rules.In recent weeks, Government bonds fell after political speculation increased around the potential return of Greater Manchester mayor Andy Burnham to Parliament.Mr Burnham has previously criticised the UK’s approach to financial markets and is viewed by some analysts as a potential political challenger.The political backdrop comes as Labour faces challenging polling data and falling approval ratings for the Prime Minister.The party is expected to face a difficult set of results at May local elections, which could increase political pressure on the leadership.Financial markets are expected to continue reacting to political developments alongside economic data and monetary policy decisions in the coming weeks.
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