Pound calm after Starmer backs Reeves, following bond sell-off – business live

UK sterling and bond markets have stabilized following yesterday's sharp selloff, which was driven by uncertainty surrounding Chancellor Rachel Reeves's position and the Labour government's fiscal credibility. The market calm, with sterling marginally higher at $1.3646, follows Keir Starmer's explicit backing for Reeves, reassuring investors concerned about less fiscally disciplined alternatives. Analysts suggest the market's negative reaction to potential change reinforced Reeves's role, highlighting the critical importance of perceived fiscal adherence, especially given a reported £5bn budget gap from welfare reform.

Analysis

UK sterling and government bond markets have stabilized after a significant selloff driven by political uncertainty surrounding the future of Chancellor Rachel Reeves. Sterling recovered marginally to $1.3646, a 0.08% rise, after falling a full cent from $1.3745 the previous day when it was the world's worst-performing major currency. The trigger for the volatility was Prime Minister Keir Starmer's initial failure to explicitly back his Chancellor, which stoked investor fears of a pivot away from fiscal discipline. The market's negative reaction, which saw bond prices slump and borrowing costs rise, appears to have reinforced Reeves's position, as highlighted by analysts from Berenberg Bank who noted that investors "probably saved the Chancellor." The core of the market's anxiety stems from a £5bn hole in the government's budget plans following a U-turn on welfare reform. This exposes what Panmure Liberum's chief economist calls an "intractable problem": the Labour government's credibility with financial markets hinges on fiscal rules that are incompatible with its manifesto commitments, particularly amid sluggish growth and a high tax burden. The Prime Minister has since offered his full support, but the underlying fiscal challenge remains, suggesting potential tax rises may be necessary in the autumn budget to maintain market confidence.

Key Decisions for Investors

• While the immediate political risk to UK assets has subsided with the Prime Minister's backing of Chancellor Reeves, investors should remain cautious as the underlying £5bn fiscal gap and conflict between spending plans and fiscal rules create significant long-term vulnerability.
• The market's sharp, negative reaction has established Rachel Reeves as a key anchor for fiscal credibility; her political security and any deviation from stated fiscal rules should be monitored as a primary sentiment driver for sterling and gilts.
• Given the political difficulty of implementing spending cuts, investors should anticipate the possibility of tax increases in the autumn budget as a means to close the fiscal gap, which could impact UK corporate earnings and consumer-focused sectors.