File image of Starmer and Reeves. Image licensed as CC BY-NC-ND 2.0.
Pound sterling fell against the euro, dollar and its other G10 peers.
Weakness followed an unscheduled speech by Chancellor Rachel Reeves that confirmed she was ready to raise income taxes and break her party's pre-election manifesto pledge that ruled out such a move.
Speaking at Number 11 Downing Street, Reeves said last year she "fixed the foundations" of the economy but that since then "the world has thrown even more challenges our way".
Asked about the manifesto promises not to raise income tax, National Insurance or VAT, she said: "As Chancellor, I have to face the world as it is not the world that I want it to be."
Following the announcements, the cost of UK borrowing fell, confirming that the market does see the Chancellor reaffirming a commitment to staying within her fiscal rules by breaking her manifesto promise not to raise one of the 'big lever' taxes.
The yield on 10-year UK bonds – the interest rate the government pays to borrowers – fell six basis points to 4.38%, declining faster than comparable economies such as Germany, France and the U.S.
Those falling bond yields were automatically reflected in currency markets, where the pound to euro exchange rate dropped to 1.1372, 0.26% lower on the day.
The pound to dollar exchange rate fell to a new seven-month low at 1.3094. Elsehwere, the UK currency was down 0.70% against the yen and erased it's post-RBA announcement gain against the AUD.
Above: GBP/EUR at daily intervals (top panel) and the shrinking difference between the UK and German 10-year bond yield.
"Sterling falls sharply as Reeves builds case for tax hike," says Neil Wilson, analyst at Saxo Bank. "Reeves delivered a surprise speech today to set out ‘Labour values’ that will guide her Budget on 26 November...ie tax hikes are coming. This could well be a manifesto-breaking hike to income tax."
Falling borrowing costs imply the market sees a smaller risk that the Chancellor triggers a Liz Truss-style market selloff, which she will be pleased with.
However, that's where the positives end: falling yields also imply the market is marking lower the economy's growth potential under an increasingly heavy tax burden.
A weaker economy implies softening inflation trends and more Bank of England interest rate cuts. More cuts to Bank Rate meanwhile weigh on near-term bond yields, which weigh on the pound.
Another risk to consider is this manifesto break will be politically dangerous for Reeves and Prime Minister Starmer, and raises the odds both are replaced before the next election, potentially bringing in a populist replacement.
"Even though a general election would still be a long way away, a Labour party under a new leadership that would then presumably deprioritise fiscal consolidation, under pressure from Reform, could put the UK back on bond vigilantes’ radar – for all the wrong reasons," says a note from Investec.
For the pound, heightened political uncertainty won't be welcome.