UK Markets Digest Political Turmoil as Starmer Faces Pressure

Political Uncertainty Drives Bond and Currency Moves

The UK government bonds experienced a sell-off as investors reassessed political risks following the resignation of Prime Minister Keir Starmer's chief aide. Gilt yields rose by approximately 2 basis points across the curve, indicating renewed concerns about stability in Westminster.

The British pound (sterling) was notably affected, falling to its weakest level against the euro since January, dropping around 0.5% against the single currency and also slipping modestly against the US dollar. This decline extends recent losses for sterling, which had already been under pressure due to a dovish stance from the Bank of England (BoE) and ongoing domestic political uncertainty.

Betting markets now suggest a greater than 70% chance that Starmer will leave office by the end of the year, adding another layer of uncertainty for UK assets. However, the market's reaction has been relatively measured compared to previous political crises.

FTSE 100 Rallies Despite Domestic Headwinds

Despite the domestic political concerns, UK equities, particularly the FTSE 100 and FTSE 250, posted gains, aligning with broader European market trends. This rally was driven by a global risk-on sentiment and firmer commodity prices.

Miners led the advance as metal prices strengthened, benefiting the resource-heavy FTSE 100. Banks also contributed to the gains, while defense stocks saw an uptick due to ongoing geopolitical tensions and increased spending commitments.

The disconnect between the weakness of the currency and the strength of equities highlights the international nature of the FTSE 100, where approximately 75% of revenues are earned overseas. A weaker pound can enhance profits for many companies when converted back into sterling.

Interestingly, the FTSE 250, which is more exposed to the domestic economy, also rallied, suggesting that investors are looking beyond the immediate political drama and focusing on broader market drivers such as interest rate expectations and corporate earnings.

NatWest Deal Sparks Shareholder Concerns

NatWest shares fell sharply after the bank announced its acquisition of wealth manager Evelyn Partners for £2.7 billion, marking its largest acquisition in over a decade and a significant strategic shift into wealth management.

Analysts expressed concerns about potential pressure on near-term share buybacks as the bank integrates the acquisition. NatWest has been returning capital to shareholders through buybacks funded by the government's ongoing stake reduction, a program that may now face disruption.

While the acquisition adds approximately 186,000 clients with £58 billion in assets under management, investors are cautious about whether the price tag represents value, given the mixed track record of wealth management deals in banking.

Labour Market Shows Tentative Signs of Stabilisation

A recent hiring survey indicated early signs that the downturn in the UK labour market may be easing, despite rising employment costs. Permanent recruitment continues to decline, but at the slowest pace in 18 months.

This data suggests that employers are adapting to higher wage bills following recent increases in employer National Insurance contributions. While hiring remains subdued, the pace of deterioration has slowed significantly from late 2024.

This tentative stabilisation is crucial for BoE policy, as the central bank has expressed concerns about wage growth and employment costs, viewing them as key determinants of persistent inflation. However, further labour market data will be necessary to confirm whether this represents a genuine turning point or merely a temporary pause in the downturn.

What It Means for Traders

The divergence between UK assets presents a nuanced narrative. Sterling and gilts reflect domestic political concerns and a dovish BoE stance, while equities benefit from global risk appetite and commodity strength.

Forex traders may find opportunities in sterling weakness, particularly against the euro, where the gap has widened significantly. Political uncertainty could keep the pound under pressure in the near term.

Equity traders might view weakness in the FTSE due to political headlines as potential buying opportunities, given the index's international revenue base. The disconnect between domestic politics and corporate earnings could lead to mispricings.

For bond traders, the situation is more complex. While political uncertainty typically drives safe-haven flows into gilts, the UK's fiscal position and inflation backdrop may limit this dynamic, suggesting that higher yields could persist even as political noise subsides.