Pound Sterling Washed Away by Reeves' Tears


Image: Parliament TV.


Gilt yields up, Pound Sterling down, it can mean only one thing: markets are fretting about UK debt again.

The selloff in the British Pound and UK bonds - which spiked bond yields - signals rising market anxieties over the UK's debt position.

The sudden market moves appear linked to an emotional appearance by the UK's finance boss - Chancellor Rachel Reeves - before Parliament.

Reeves was seen crying on the front benches during Prime Ministers Questions, in which the PM was questioned about why he abandoned reforms to the UK's welfare system.


Above: The Pound to Euro exchange rate falls as bond yields (lower panel) rise. Usually, the two assets are positively related. Breakdowns are associated with market worries about UK debt. Think back to Liz Truss' mini budget.


Reeves' tears are more than an emotional expression of the challenges she faces; for markets it's a visible signal of a government that can't control the UK's fiscal trajectory.

"Reeves was visibly upset in Parliament today, but markets are dispassionate and coldly analytical. Global investors will see only a weak Chancellor, unable to control the far-left of her party at a time when UK fiscal credibility is at stake," says Kallum Pickering, Chief Economist at Peel Hunt.

"A worrying development is taking place: the pound is now the weakest currency in the G10 FX space, as the pound falls and yields rise. This is a sign of fiscal stress," says Kathleen Brooks, research director at XTB.

Starmer on Tuesday was forced by his party peers to abandon changes to the welfare system that would have resulted in the savings of a mere £5BN.

That he can't deliver such slender savings means the UK's debt trajectory will hurtle in an unsustainable direction, making investors in UK government bonds nervous as to whether the country will remain a safe bet.

"The serious tail risk now is that, unless Starmer and Reeves show that they can bring the fiscally irresponsible party fringe under control, the UK may face a continual risk of fiscal crisis until the next election," says Pickering.

For Reeves, assuming she stays in place, the abandonment of welfare reform leaves her no choice but to raise taxes again in the Autumn, something investors fear will kill economic growth. And it is economic growth that guarantees the future payment of the country's debts; without it, default looms.

Pound Sterling Live has been warning about such risks to the Pound for some weeks now, but we thought this was a story for later in the year, not so soon.

The financial market reaction could also signal concerns about what would happen if Reeves were to be replaced, considering the left wing of the Labour Party appears to be in the ascendency.

"The sharp rise in bond yields happened during PMQs, the leader of the opposition asked the Prime Minister if he would confirm if Rachel Reeves would remain as Chancellor. The PM refused to say that the Chancellor would remain in position until the end of this parliament as a visibly distressed Reeves was watching on," says Kathleen Brooks,

"Slower UK growth will impact factors such as government finances and could therefore contribute to further stresses for the currency down the road," Jane Foley, Senior FX Strategist at Rabobank. "The UK’s weak growth, low productivity backdrop and high level of government debt are all restraining influences for the pound medium-term."



Starmer's decision to abandon efforts to cap the UK's growing welfare bill were expected to provide the necessary savings required to ensure the UK Treasuery, which Reeves heads, will maintain its fiscal rules.

These rules state that the spending, tax and borrowing plans must be such that borrowing as a percentage of GDP must start falling in the medium-term.

The rules are a useful set of guardrails to ensure government spending discipline. However, for markets, no such thing exists.

Instead, the market acts as soon as it sees trouble, and that trouble is in sight now.

"The market is turning vigilante here and showing a distinct lack of confidence and implication that we could see more borrowing; pricing in higher political risk premium. This kind of market reaction is everything Labour hoped to avoid - they staked so much on their fiscal credibility but it's all gone up in a backbench revolt," says Neil Wilson, UK Investor Strategist at Saxo Markets.


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