The City delivered its verdict on Friday, sending UK borrowing costs sharply higher and the pound tumbling as the latest chapter of Westminster’s leadership drama unfolded. The yield on the 10-year gilt rose 12 basis points to 4.38 per cent, its highest level in three weeks, while sterling slid below $1.
26 against the dollar. Investors, it seems, are pricing in a premium for political uncertainty. The turbulence was triggered by reports of a plot to oust the Chancellor, with backbench MPs frustrated over the pace of fiscal consolidation.
In response, the Treasury issued a statement vowing to “maintain fiscal discipline and ensure debt is falling as a share of GDP.” But the markets were not buying it. Not entirely.
The cost of insuring UK sovereign debt against default, measured by credit default swaps, also edged higher. This is not a crisis, not yet. It is a warning.
The bond market is the ultimate discipline for governments. When the headroom for error shrinks, as it has after the inflationary shock and the Bank of England’s rate hiking cycle, even a whiff of fiscal laxity triggers a repricing. The irony is that the Chancellor’s critics argue he is being too cautious, holding back growth.
Yet the market reaction suggests the opposite: that any deviation from the fiscal rules will be punished. The pound’s fall, meanwhile, compounds the inflation headache. A weaker sterling feeds through to higher import prices, particularly for energy and food.
That could delay the Bank of England’s path to rate cuts, further squeezing the economy. So here we are again. A vicious cycle of political noise, market volatility and economic fragility.
The Treasury’s vow of discipline is necessary but not sufficient. What the markets want to see is delivery. And that requires a stable government, a credible plan and an independent central bank focused on price stability.
A tall order, given the current mood in Westminster. For now, the cost of government borrowing is rising, the pound is falling, and the margin for error is getting thinner. The bottom line: trust is a fragile commodity in financial markets.
And it is being tested once more.
