Traders Bet Against Pound as Burnham Joins PM Race

Rising Concerns Over the Pound Amid Political Instability

Currency traders are increasingly betting against the British pound as political instability continues to affect the government. Recent data indicates a growing sense of uncertainty among investors, with speculators steadily increasing their sell positions in recent weeks. This trend reflects concerns over potential shifts to the left following a prolonged leadership challenge within the Labour Party, led by Sir Keir Starmer.

The pound experienced its fifth consecutive day of decline on Friday, falling to $1.33 after Manchester Mayor Andy Burnham was cleared to stand for Parliament. This development marks a significant step towards challenging the Prime Minister's position. A weaker pound has several implications, including more expensive foreign holidays and imported goods such as fuel, food, and electrical items. Additionally, it could lead to higher mortgage rates if interest rates need to be increased to support the currency.

Fears that fiscal rules limiting borrowing might be relaxed to fund more welfare spending have already resulted in a surge in borrowing costs since Labour faced a setback in this month’s local elections. The yield, or interest rate, the government pays on its benchmark ten-year gilts has surpassed 5%, reaching its highest level since the 2008 financial crisis. This increase is attributed to the prospect of Burnham taking control of No.10, which has unsettled investors.

Burnham has previously stated that Britain should not be "in hock" to the bond markets. However, yields rise as gilt prices fall, and the current sell-off in gilts is spilling over into currency markets, raising concerns about a potential run on the pound. Traders have been negative on the currency for almost a year. According to the latest data from the Commodity Futures Trading Commission, up to 64,000 net bets have been taken out against sterling, worth nearly £4 billion—the highest in two months.

"Politics is hammering sentiment towards sterling," said Neil Wilson of investment bank Saxo. Mark Dowding of asset manager RBC BlueBay is also divesting from the pound, stating, "UK financial assets and sterling seem likely to be subjected to an elevated political risk premium for an extended period."

Britain's reliance on foreign investors to manage its finances is growing, with over a quarter of its national debt held abroad. These investors lend to the government to cover the gap between its spending and tax revenue. However, crucially, the UK runs a trade deficit, where imports exceed exports, adding downward pressure on the pound as the country must sell sterling to buy foreign currency for imported goods and services.

"We are reliant on the kindness of strangers, so any sell-off in gilts would be likely to take the pound lower," said Jane Foley at investment bank Rabobank.

The last time bonds and the pound fell together was after the disastrous Liz Truss mini-Budget in 2022, when hidden borrowing in parts of the pension system was exposed, leading to a Bank of England bailout. Although current government borrowing costs are higher than before, they have not risen as quickly as four years ago, and the pound is well above the near-parity it briefly reached against the dollar during that time.

The bond sell-off has also affected the value of millions of workplace pensions, particularly for those nearing retirement who are automatically 'de-risked' into supposedly safe 'lifestyle' funds that primarily invest in bonds and other fixed-income investments.

"If you own bonds in your pension or elsewhere, you will find their value has fallen significantly—by 20 per cent in the past few days for some gilts—and there's no upside," said industry expert Henry Tapper.