Pound-Euro Rate in Shaky Start to a Week of Political Intrigue

Picture by Simon Dawson / No 10 Downing Street

Pound sterling gapped lower against the euro in early Asian trade on Monday as markets digested weekend news that showed Prime Minister Keir Starmer's hold on the Labour Party was slipping.

It's been a weekend of fevered speculation about the Prime Minister's future, and traders will have been forgiven for pricing some political uncertainty into the pound-to-euro conversion, which fell from 1.1570 to 1.1535 in relatively short order.

It's since pared most of those losses, suggesting there's no real sense of panic emerging in the market, even if there's a definite sense of nervousness.

The Labour Party received a drubbing in last week's local and devolved elections and MPs in Parliament know their jobs are on the line and are desperate for some kind of reset.

"For the pound, the decisive phase has only just begun, with an uncertain outcome," says Michael Pfister, currency strategist at Commerzbank.

The market is worried that Starmer and his finance chief, Rachel Reeves, will ultimately exit Downing Street, and with them the commitment to spending discipline.

There's talk of a "stalking horse" leadership challenge from an unheard-of MP, while the usual names of Burham, Rayner and Streeting are also being discussed in the press as challengers.

For his part, Starmer has indicated he is going nowhere, enlisting Labour 'big beasts' Brown and Harman to his cabinet to help prevent any mutiny.

Above: GBP/EUR gaps lower at the open.

Only when Cabinet members start resigning will Starmer have to concede it's over, and we're a long way from that point and suspect that Starmer will hold on.

Nevertheless, a period of political intrigue should be enough to keep a lid on pound-euro upside potential in the coming days and we could look for a steady drift back towards Monday's lows at 1.1535 in the coming two days.

We suspect GBP/EUR downside will be relatively limited if Starmer digs his heels in, as that will allow market focus to wander elsewhere. For the pound, that would prove supportive thanks to Britain's elevated bond yields.

If political risk fades, the attractiveness of UK bonds to international investors could prove supportive and help the GBP/EUR exchange rate back towards 1.16, and maybe even above, later in May.

Above: GBP/EUR is well supported medium-term, albeit still constrained by the 1.16 barrier.