Sterling has steadied against the single currency at 1.1563 amid hopes that the UK government has recognised the need to avoid further missteps in public finances, yet the harm has already been done.
Prime Minister Keir Starmer assured the BBC that Chancellor Rachel Reeves will remain in her position. He aims for this reassurance to ease tensions in the bond and Sterling markets by reaffirming his government’s dedication to responsible fiscal management.
These developments followed a decline in the Pound and UK bonds during Starmer’s parliamentary appearance alongside Reeves.
The Pound to Euro exchange rate dropped to 1.1535 in midweek trading, with the selloff beginning during Prime Minister’s Questions.
The Pound to Dollar exchange rate, previously showing little reaction to UK events, dropped by 1% to 1.3562. Meanwhile, the yield on the UK 10-year gilt increased to 4.611%.
Some market and political analysts believe that Starmer’s failure to confirm Reeves’ continued position led to the subsequent drop in the Pound’s exchange rates and gilt prices. They warn that if Reeves is replaced, a left-wing ideologue could take over, potentially causing significant damage to the country, Pound Sterling Live reports.
“The market reacted with shock and punished the Pound, sending 10-year interest rates skyrocketing,” according to FX Analyst at Commerzbank, Antje Praefcke.
Despite Starmer’s reassurances, doubts remain about Reeves’ job security, and it is undeniable that the government is struggling to maintain control over public finances. This situation points to further potential pressure on the Pound.
Furthermore, the increase in bond yields adds to the government’s challenges, indicating that borrowing costs have risen as investors seek higher returns for holding UK gilts.
This loss of confidence comes after the government backed down on efforts to reduce its substantial welfare spending: in March, Chancellor Reeves had proposed cuts to the Personal Independence Payment (PIP) component to save approximately £5 billion annually.
However, the proposed reforms sparked a rebellion within the Labour Party, which the PM was reluctant to confront.
As a result, the welfare bill set to pass Parliament will cost £3 billion more than initially projected.
Markets now recognise that there is neither the political will nor the support to control spending, placing the UK’s finances under significant strain. This likely means cuts in other departments, increased borrowing, and higher taxes.
However, the market’s willingness to finance additional debt is limited, as evidenced by rising gilt yields, forcing the government to significantly increase taxes later in the year.
This poses a problem for the Pound, since higher tax rates could actually generate less revenue if businesses and investors adjust their strategies to minimise their tax burden.
“Although Starmer repeatedly emphasised afterwards that he fully backed his finance minister, the damage has been done. The market can no longer be sure that budgetary discipline will really be maintained in the UK. It is irrelevant whether Reeves can continue, or whether and, if so, who Stamer will choose as her successor – the damage to the Pound and long-term interest rates has been done,” Commerzbank’s Praefcke added.