The City is staring into the abyss this morning. Sterling has crashed through key support levels, plumbing depths not seen since the Truss mini-bond calamity, as the Westminster leadership crisis spirals into a full-blown confidence vacuum. The pound has shed over 2% in early Asian trading, breaching $1.18 against the dollar, while the yield on the benchmark 10-year gilt has spiked 25 basis points to 4.65%. This is capital flight, pure and simple. The market is pricing in a risk premium for political dysfunction.
The trigger is a no-confidence motion against the Prime Minister, with backbench rebels openly briefing that a leadership contest is inevitable. The usual channels of governance have seized up. Treasury officials are reportedly locked in emergency meetings, but the fiscal arithmetic is brutal: borrowing costs are rising at the exact moment the government needs to borrow more to plug a gaping deficit. The Office for Budget Responsibility's latest forecast, already grim, now looks hopelessly optimistic. The bond vigilantes are back, and they are not listening to soothing words from Number 10.
The irony is that the economic data, until this week, showed modest resilience. Inflation had begun to ease, GDP was treading water, and the labour market was cooling without collapsing. But politics trumps economics in a crisis. The market does not care about the trailing indicators; it cares about the next six months. And the next six months look like a power vacuum, a potential general election, and a paralysis of fiscal policy.
The Bank of England is in a bind. They cannot raise rates to defend the pound without crushing what little growth remains. But they cannot ignore the plunge in sterling either, as it feeds directly into imported inflation. The MPC will be watching the 10-year yield spread over bunds widen to 200 basis points. That is a vote of no confidence in UK sovereign creditworthiness.
Finance directors up and down the country are now facing a nightmare scenario: their hedging costs are exploding, their pension fund deficits are ballooning as gilt yields spike (raising liabilities), and their export competitiveness is a mirage because global demand is weakening. The capital flight is not just hot money. We are seeing real money, long-term investors, rotate out of UK assets. The London Stock Exchange is bleeding listings, and this will accelerate.
The Prime Minister's fate is to be decided within days. But even a new leader faces the same structural problems: a creaking public sector, a tax burden at a 70-year high, and a private sector gasping for investment. The market is saying, enough. Stop the political theatre and start showing fiscal discipline. Otherwise, the next steps are a gilt auction failure, a begging letter to the IMF, or both.
In the meantime, the carry trade is dead. Anyone holding long-dated gilts is getting slaughtered. The prudent investor is in cash, short sterling, and waiting for the political storm to pass. But storms have a habit of becoming hurricanes when the foundations are weak. This one is far from over.
