Sterling & Gilts Bear the Brunt as Westminster's Political Crisis Deepens.
Summary
Sterling weakened and gilt yields surged to multi-decade highs last week as more than 70 Labour MPs called on Prime Minister Starmer to resign, raising the prospect of a leadership change and a looser fiscal stance
Kevin Warsh was confirmed as Fed Chair by the Senate on Wednesday in the most partisan confirmation vote in the role's history; his first FOMC meeting is scheduled for 16-17 June
US CPI for April came in above forecast at 3.8% annually, the highest since May 2023, driven primarily by energy; US retail sales held up at 0.5% month on month, in line with expectations
UK Q1 GDP grew 0.6% quarter on quarter, matching consensus and led by the services sector, though economists were quick to note the data predates the conflict in the Middle East and Q2 is expected to look very different
The dominant story for sterling last week had nothing to do with data. As the scale of Labour's local election losses became clear and the number of MPs calling for Starmer's resignation climbed past 70, gilt yields surged to levels not seen since the late 1990s, with the benchmark 10-year yield trading above 5%. Markets were pricing in the risk that a new, more left-leaning Labour leader would loosen the fiscal rules maintained by Chancellor Rachel Reeves, increasing government borrowing and gilt issuance. Analysts at Deutsche Bank noted that the rise in long-end yields reflected exactly that concern. Eurasia Group raised the probability of Starmer being removed from office this year to 80%.
By midweek, the immediate threat had eased. The King's Speech on Wednesday gave Starmer's government a platform to reset, and with 158 Labour MPs publicly backing him against 93 calling for his exit, no challenger had yet emerged with sufficient numbers to force a formal contest. Gilt yields pulled back from their highs, though they remained elevated. Health Secretary Wes Streeting, widely seen as a potential rival, met Starmer at Downing Street on Wednesday. Andy Burnham, the Mayor of Greater Manchester, announced he would stand in the Makerfield by-election after its sitting MP stepped aside to give him a route back into parliament. Markets remain on edge. Political uncertainty of this kind has a direct impact on sterling and gilt yields, and the situation is far from resolved.
Thursday's UK GDP release offered some relief in isolation. The economy grew 0.6% in the first quarter, its fastest quarterly rate in a year, driven by broad-based gains across the services sector. The March monthly reading of 0.3% was also stronger than the consensus forecast of a contraction. However, economists at the National Institute of Economic and Social Research were clear that the Q1 figures reflect activity before the Middle East conflict took hold, and that forward-looking indicators including business confidence and input price inflation have already deteriorated. The quarterly data was almost immediately overshadowed by the political turmoil unfolding in the same week.
Across the Atlantic, the week's data reinforced the Fed's difficult position. US CPI rose 3.8% in the year to April, above the 3.7% forecast and the highest annual reading since May 2023, with energy accounting for more than 40% of the monthly increase. Core inflation also edged higher to 2.8% annually, above forecast, driven in part by a statistical distortion in shelter costs linked to last year's government shutdown. US retail sales held steady, rising 0.5% on the month and in line with expectations.
The consumer is still spending, but real wage growth has turned negative for the first time in three years, and the University of Michigan's consumer sentiment index fell to an all-time record low in early May. Kevin Warsh was confirmed as Fed Chair by the Senate on Wednesday in a 54-45 vote, the closest and most partisan confirmation in the modern era. Markets will be scrutinising the minutes of the April FOMC meeting, due Wednesday, for clues on how the Committee intends to navigate an environment of rising inflation and softening growth.
Events to Watch This Week
Tuesday 19 May: UK labour market data (March)
Wednesday 20 May: UK CPI (April); FOMC April meeting minutes
Thursday 21 May: Flash PMIs for UK, eurozone and US (May)
Friday 22 May: UK retail sales (April)
Wednesday is the week's most significant day, with UK inflation data and the FOMC minutes both landing on the same morning. A hotter-than-expected UK CPI print could add pressure on the Bank of England and provide some support to sterling at a moment when it needs it most. Speak to the Orbis dealing team ahead of Wednesday's releases to ensure your upcoming transfers are protected.
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