Pound Sterling Better Composed as Cabinet Rallies Around Starmer

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Picture by Simon Dawson / No 10 Downing Street

The British pound has rallied from its lows as it appears the Prime Minister has nipped a rebellion in the bud.

The UK currency and government bonds were under pressure for most of Monday as Keir Starmer's grip on power was threatened by a series of resignations linked to the Mandelson-Epstein affair.

However, by the afternoon, a fightback by 10 Downing Street was underway,  which appears to have calmed financial markets and helped the pound compose itself.

The pound to euro exchange rate recovered from a low of 1.1444 to reach 1.1484 as members of Starmer's cabinet, and even potential replacements, publicly stated their support. Analysts are particularly focused on the pound- euro exchange rate as a gauge of stress, judging this to be the purest expression of UK-specific risks in the current market setup.

"We would prefer to play latent political risk via looking for EUR/GBP topside and or Gilt underperformance vs Bunds. In terms of fixed income dynamics we are mindful of any potential leadership change risking a looser fiscal stance," says Jeremy Stretch, Chief International Strategist at CIBC Capital Markets.

Sterling was under particular pressure after Labour's Scottish leader, Anwas Sanwar, publicly called for the Prime Minister to go.

The risk was that this move opened a floodgate to further calls. As recent history shows, once cabinet members start resigning, the game is effectively up.

But a coordinated series of 'tweets' on X, saw the top table fall in line behind their leader.

Angela Rayner, touted as a potential replacement, also publicly gave her backing.

UK gilt yields - the effective interest rate paid by bonds - fell back from earlier highs, in a sign markets believed the Prime Minister was beyond the danger zone.

"We do have the clarifying moment of the by-election coming up but still there does not seem to be an alternative leader that MPs can quickly rally around (Burnham not in parliament, Streeting not from the left of the party, Rayner recently resigned from Cabinet)," says a note from Goldman Sachs.

The analysis adds that leaders can hang on with tenacity, for example, Theresa May. And, "no leader in the UK is really pushing unfunded spending, the likely worse case is a watering down of the fiscal rules."

Citi is also wary about jumping into this trade, saying in a daily update: "Gilts underperform on UK political risk premium, we would be wary chasing." After all, Starmer has a massive majority and there's no real rump of MP's outright calling for his resignation.

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"Starmer will meet MPs today after market close and in the meantime we monitor if Cabinet resignations occur. Our sense is that a leadership change is increasingly inevitable, but that flashpoint is not necessarily here," says Citi. Once we see lists circulate with MP names, the game will truly be afoot.

A political crisis that began last week over the Prime Minister's appointment of Peter Mandelson escalated through the London morning:

✳️ Starmer’s director of communications, Tim Allan, stepped down on Monday morning for a "new team to be built".

✳️ Morgan McSweeney on Sunday resigned as No 10’s chief of staff over his part in the decision to appoint Peter Mandelson as ambassador to the U.S. The release of the Epstein files last week revealed the depths of Mandelson's connections to the disgraced paedophile financier, including the leaking of sensitive government information.

The resignations fueled fevered speculation about the Prime Minister's future, similar to the episodes leading up to the resignations of Theresa May, Boris Johnson and Liz Truss.

The concern for markets is that in the event of Starmer's resignation, a replacement is chosen who leans towards the left of the Labour Party.

Any commitment to market-friendly reforms and fiscal discipline could well leave 10 Downing Street in Starmer's suitcase. For the pound and gilts, the moment is fraught with risk.

Political commentators say Starmer won't fully recover from the hit to his authority, and it's only a matter of time before the knives come out. This should ensure the pound retains a risk-related premium over the coming months.

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