Sterling takes by-election result 'in its stride' – Markets weary of protracted leadership contest

Sterling has taken yesterday’s by-election result in Makerfield in its stride.

Aside from the fact that the outcome of the vote was largely priced in, we see a few reasons for this apparent complacency, namely Burnham’s pledge to stick to the borrowing rules and the limited fiscal headroom on offer, which would significantly cap the ability of any new Labour leader to lurch further to the political left.

In the near-term, perhaps the worst-case scenario for markets is a protracted leadership contest and a period of political paralysis should Starmer dig his heels in and refuse to resign.

In the longer-run, we see further downside in both the pound and gilts should Burnham pursue policies that could reasonably damage fiscal sustainability. The proof will, of course, be in the pudding.

Meanwhile, the Bank of England sprung no real surprises on Thursday. The base rate was held in a 7-2 vote, with the two hawks (Pill and Greene) the only officials to opt for a hike.

The language in the communications suggest to us that the MPC is keeping its options open to hike later in the year, with a handful of members saying that they would support a rate increase should second-order effects become evident.

Yet with the Iran war ending and the UK labour market weak, we do not think that these second-round effects will materialise to the extent that would warrant MPC tightening. With swaps still fully pricing in a hike later in the year, we could see some downside in the pound should the BoE stay on hold in 2026.