The British pound dropped sharply against the dollar and euro on Thursday, while government borrowing costs hit multi-year highs, as a deepening political crisis at Westminster rattled investor confidence. Sterling fell by 1.8% to $1.2040 in afternoon trading, its lowest level since November 2022, as the yield on 10-year gilts rose 15 basis points to 4.45%, the highest since the 2008 financial crisis. The moves reflect growing anxiety over the stability of the UK's fiscal outlook, following the resignation of the Chancellor of the Exchequer and two junior ministers within 24 hours.
The crisis began on Wednesday when the Chancellor abruptly stepped down, citing irreconcilable differences with the Prime Minister over economic policy. Hours later, two Treasury ministers followed suit, leaving the government's economic team in disarray. Investors interpreted the departures as a signal that the government's fiscal discipline is fracturing, just as the Bank of England struggles to contain inflation at 8.7% and the economy teeters on the edge of recession.
"This is a classic flight from risk," said Dr. Alistair Finch, a macroeconomist at the London School of Economics. "The pound is acting as a barometer of political credibility, and right now the barometer is in freefall." The sell-off in gilts pushed the yield spread between UK and German 10-year bonds to its widest since the eurozone debt crisis, a sign that investors are demanding a higher premium for holding UK debt.
The immediate trigger for the sell-off was a leaked Treasury document suggesting that the government may need to borrow an additional £30 billion this fiscal year to fund promised tax cuts, a scenario that would strain the country's already stretched public finances. The Office for Budget Responsibility had previously warned that the UK's debt-to-GDP ratio was on an unsustainable path, and the latest political turmoil has amplified those concerns.
For context, the UK's underlying debt currently stands at 101% of GDP, and interest payments on that debt have already consumed 8.3% of government revenue, up from 5.1% two years ago. If borrowing costs remain elevated, that figure could rise to 12% by 2025, crowding out spending on health, education, and infrastructure. The Bank of England faces a difficult balancing act: raising rates to combat inflation could further destabilise markets, but holding steady risks embedding price rises into wages and expectations.
"We are observing a classic feedback loop," noted Dr. Helena Vance, our science and climate correspondent. "Political instability drives up borrowing costs, which worsens the fiscal outlook, which in turn deepens the crisis. It's a self-reinforcing process that can tip an economy from stagnation into a full-blown debt spiral." She drew a parallel to the energy transition, where uncertainty over policy can freeze investment: "When governments signal that they might renege on commitments, whether on fiscal policy or climate targets, the private sector responds by pulling capital. We are seeing the same dynamic here, only in real time."
The leadership crisis has also raised questions about the government's ability to respond to other pressing challenges, including the ongoing threat of climate-related disruptions. The UK has committed to net-zero emissions by 2050, a goal that requires roughly £1.4 trillion in investment over the next three decades. A disorderly fiscal situation could delay or reduce those investments, exposing the country to the physical risks of a warming planet: more frequent floods, heatwaves, and crop failures.
"The immediate economic turmoil may seem disconnected from climate policy, but they are linked by a common thread of trust," said Dr. Vance. "Investors need to believe that governments will follow through on long-term plans. When that trust shatters, the cost of capital rises for everyone, including the green projects we urgently need to fund."
As the sun set over Westminster, the final blow to markets came from a hastily scheduled evening press conference. The Prime Minister, looking visibly strained, refused to rule out a snap election but offered no concrete plan to restore fiscal credibility. Sterling slid another 0.5% on the statement. The crisis, now entering its third day, shows no signs of abating. For investors and citizens alike, the only certainty is volatility.
