Market News

(Bloomberg) -- The pound dropped to a more than one-year low, stocks fell and gilts extended a fourth day of losses on concern the Labour government will struggle to keep the deficit in check as borrowing costs surge.

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Sterling retreated for a third session, down as much as 1% to $1.2239, the lowest since November 2023. Gilts declined sharply at the open, with the 10-year yield rising as much as 13 basis points to 4.92%. The UK’s domestically-focused FTSE 250 Index fell as much as 1.1% to the lowest since April, and was on course for its worst three-day drop since August.

The nation’s assets are at the forefront of a global rout fueled this week by Donald Trump’s latest threats to impose tariffs and worries that inflation will remain elevated for longer than expected. The speed of the moves has seen comparisons drawn to the fallout from Liz Truss’ ill-fated mini-budget in 2022, and prompted questions to UK lawmakers in Parliament.

While market structure has been strengthened to prevent a crisis of that scale, the government’s escalating debt burden is once again a source of concern for investors. A former Bank of England policymaker has even drawn parallels to the 1976 debt crisis, which saw the UK government ask the IMF for a bailout. Treasury officials have described the move as ‘orderly.’

“The worry is that investors have just lost faith in the UK as a place to put their assets,” said Eva Sun-Wai, a fund manager at M&G Investments, on Bloomberg Radio.

Sun-Wai added the pound’s drop despite a surge in yields can be seen as a signal of capital flight, as normally higher returns would make a currency more attractive. The move prompted jokes in the City and beyond, with Citigroup describing sterling as the “Great British Peso” — a reference to a more volatile emerging-market currency.

“The pound could remain the preferred pressure valve for anxious investors who worry about the outlook of their UK portfolios,” said Valentin Marinov, head of Credit Agricole’s Group-of-10 FX strategy in London. “Markets are quite skittish at the moment. FX traders will continue to ‘milk’ the heightened FX volatility for whatever it’s worth.”

The sharp declines in UK assets seen at the market open later pared. The pound traded 0.7% lower as of 12:32 p.m. in London and the five-year gilt erased losses. Stocks also trimmed an earlier decline.

Darren Jones, chief secretary to the UK Treasury, said in an address in parliament on Thursday that the gilt market continues to function in an “orderly way” and underlying demand for the debt remains strong.

Still, activity in the options market suggests the currency turmoil may persist, with the cost of hedging swings on the pound versus the dollar and the euro over the next week rising to the highest since the US presidential election.

Also hedge funds have been adding to sterling shorts, according to Europe-based traders, while risk reversals, a barometer of market positioning and sentiment, show traders are most bearish on the UK currency in two years.

Worst Case

While the UK still has lower debt than the US, France, Italy and Japan, investors say the selloff in British assets is a culmination of the country representing all of the worst-case scenarios for investors right now: persistent price pressures, a ballooning government debt pile and tepid economic growth.

Surging yields also suggest that gilts are having to battle for buyers’ attention at a time of heavy issuance and elevated yields globally. Yields on US Treasuries, the world’s safest asset, have also reverted to multi-year highs, but a small recovery on Thursday signaled investors were stepping back in.

Compounding the gilt market’s problems are changes in the pension industry as their investment goals shift, historically a major buyer of UK government debt. According to UBS Group AG analysis last month, pension funds have bought about £150 billion ($184 billion) of gilts since 2022 but demand has likely now dropped to £50 billion annually, on a gross basis.

“Markets are rightly nervous about depth of demand for gilts,” said Giles Gale, a strategist at UBS. “Fixed income weakness has been a global theme, but sentiment on the UK is particularly vulnerable.”

If the surge in yields is sustained, it could wipe out the government’s dwindling £9.9 billion of fiscal headroom and pressure it to tighten fiscal policy. In that case, Chancellor of the Exchequer Rachel Reeves would favor fresh cuts to public spending over tax hikes, according to people familiar with her plans.

What Bloomberg Strategists Say:

“In a classic sign of market jitters, the pound’s volatility term structure, which had a normal slope as recently as the new year, has inverted — suggesting that traders fear more downside in the short term.”

— Ven Ram, Cross-Assets Strategist, Dubai

Stocks Slump

In the equity market, homebuilders like Taylor Wimpey Plc and Barratt Redrow Plc were among the biggest undeperformers in recent sessions as swap rates that are used to price mortgages spiked. UK retail stocks also slumped Thursday as trading updates from Tesco Plc and Marks & Spencer Group Plc added to the concern around the economy.

Meanwhile, the FTSE 100, which is comprised of large, internationally-geared stocks, outperformed, rising 0.6% as its companies benefit from a weaker pound.

--With assistance from Masaki Kondo, Ruth Carson, Greg Ritchie, Joe Easton, Michael Msika and Alice Gledhill.

(Updates to elevate Treasury comments. An earlier version of this story corrected the scope of the stocks move in second paragraph.)