Sterling drops, politics and BoE easing path in focus

Sterling dropped against the dollar and the euro on Tuesday as a broad selloff of the U.S. currency faded, while concerns about British politics and the path of Bank of England monetary policy continued to weigh.

Two-year UK government bond yields GB2YT=RR were roughly unchanged after falling by almost 11 basis points since Thursday, when the Bank of England kept interest rates on hold, but only after an unexpectedly narrow 5-4 vote.

The central bank also said borrowing costs were likely to fall if an expected drop soon in inflation was sustained.

STARMER NOT QUITTING

British Prime Minister Keir Starmer refused on Monday to heed calls to quit, after a second aide resigned from a team in crisis over the appointment of Peter Mandelson as ambassador to Washington.

Former deputy prime minister Angela Rayner, seen as a potential challenger, threw her support behind Starmer on Monday.

Lee Hardman, a senior currency analyst at MUFG, noted that Labour sources indicated significant resistance within the party to launching a leadership challenge ahead of May's local elections.

"A development that should help to reduce the risk of a sharper pound selloff in the near-term," he argued.

The euro <EURGBP=> was last up 0.26% against the pound at 87.19 pence. It hit 86.96 on Monday, its highest since January 21.

"Nevertheless, it remains questionable whether Starmer will still be prime minister by the end of the year, despite winning the 2024 election with a strong result and setting out to ensure stability,” said Michael Pfister, forex analyst at Commerzbank, before mentioning signs of recovery in the British economy and easing inflation.

“The pound is currently suffering from uncertainty, and this is likely to continue until the matter is resolved sustainably,” he said.

Against the dollar, sterling fell 0.2% at $1.3669 GBP=D3.

The greenback was little changed against European currencies before key U.S. economic data due on Wednesday.

“However, the risk of a leftist turn in the government, particularly under an Angela Rayner-led Labour Party, presents downside risks to the pound and British assets generally,” said Enrique Diaz-Alvarez, chief economist at global financial services firm Ebury.

Graphic: World FX rates in 2023 http://tmsnrt.rs/2egbfVh

Graphic: Trade-weighted sterling since Brexit vote http://tmsnrt.rs/2hwV9Hv

-Reporting by Stefano Rebaudo; editing by Alex Richardson/Reuters