Last month’s election results were not only a disappointment forLabour, but well beyond the typical mid-term punishment for the incumbent government. Our base case is that Starmer's tenure ends in the near term through a formal leadership challenge - even if he somehow manages to stay on, we think that he will be forced to govern on terms dictated by the party’s left factions. Both paths lead to the same destination: a UK fiscal stance that is much more accommodative than the current one.
Sterling has functioned as a reliable proxy for UK fiscal credibility in recent years, and history seems to be repeating itself. Both the pound and gilts have already felt the heat as investors fret a fiscal programme that leans towards greater public spending, funded by further tax hikes and higher gilt issuance.
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We see further downside shouldLabour’s leadership succession deliver such a pivot to the political left. Markets have a clear intolerance for fiscal expansions that strain existing budgetary constraints, and sterling tends to be the primary adjustment mechanism when that intolerance materialises.
The recent underperformance of gilts relative to the UK’s major peers tells a similar story. Of course, much of the sell-off inUK debt can be ascribed to the energy crisis - Britain’s reliance on imported oil leaves it structurally vulnerable to the shock. Political anxiety has been the amplifier, however. Since the start of 2026, the spread between the 30-year gilt yield and the average equivalent yield of the G7 (ex. UK) has widened by more than 20bps - a gap that stretched to as much as 34bps when market conviction in Starmer’s departure reached it speak in mid-May.
Read the full report on how the Labour leadership crisis risks stalling the pound.
