The United Kingdom is facing renewed financial turbulence as political instability at the highest level sends shockwaves through markets. Government bond yields have risen sharply, and sterling has fallen to its lowest level against the dollar in six months, reflecting growing investor concern over the absence of a coherent economic strategy.
On Tuesday, the yield on the 10-year gilt climbed to 4.9 per cent, its highest point since the 2008 financial crisis. The move follows a week of infighting within the ruling party, with senior figures openly challenging the prime minister’s authority. The opposition has seized on the disarray, calling for an immediate general election.
Sterling dropped below $1.22 for the first time since November, compounding the pressure on households already grappling with high inflation. The currency’s weakness raises the cost of imports, threatening to push up prices further and delay the Bank of England’s efforts to bring inflation back to its 2 per cent target.
The Bank of England has so far resisted intervening in the currency markets, but analysts warn that a sustained sell-off could force its hand. “Sterling is now trading at levels that historically have prompted a policy response,” said a senior economist at a London-based advisory firm. “But the Bank cannot solve a political crisis.”
The political turmoil has its roots in last week’s cabinet reshuffle, which saw the abrupt dismissal of the chancellor of the exchequer. The move was widely criticised as a miscalculation that alienated moderate MPs and unsettled international investors. Since then, the government has struggled to present a unified message on fiscal policy.
Market participants are particularly concerned about the lack of clarity on public spending. The government has pledged to cut taxes to stimulate growth, but has not explained how it will fund these cuts while maintaining the public services that voters demand. This ambiguity has led to a loss of confidence in the country’s fiscal framework.
The situation bears uncomfortable similarities to the aftermath of the 2022 mini-budget, when unfunded tax cuts triggered a crisis in the gilt market and forced the Bank of England to intervene. While the current episode has not yet reached that level of severity, the trajectory is troubling.
“The United Kingdom is once again being punished for its politics,” wrote a strategist at a major investment bank in a note to clients. “Foreign buyers of gilts are becoming scarcer, and domestic investors are demanding higher yields to compensate for the heightened uncertainty.”
The impact is being felt beyond financial markets. Business groups have warned that the prolonged instability is deterring investment. The director-general of the Confederation of British Industry said that firms were “shelving expansion plans” as they waited for a clear signal from Downing Street.
There are also implications for the Bank of England’s monetary policy. Higher gilt yields have already tightened financial conditions, reducing the need for further interest rate rises. However, if sterling weakness feeds through into higher inflation, the Bank may be forced to raise rates again, further squeezing borrowers.
The prime minister’s office has sought to calm nerves, issuing statements about the strength of the economy. But the words have done little to reassure markets, which are now focused on the possibility of a leadership challenge in the coming days.
Iain MacLaughlin, a former Treasury official now at a think tank, described the current situation as “a self-inflicted wound with no easy exit.” He added: “Restoring credibility will require not just a change in policy, but a change in behaviour from the top. Until that happens, the danger of a full-blown crisis remains very real.”
