Sterling steadies after selloff, fiscal worries prevail

By Johann M Cherian

(Reuters) -Sterling edged higher on Thursday, stabilising after fiscal concerns and uncertainty about Rachel Reeves' future as Britain's finance minister sparked a selloff across UK assets in the previous session.

Markets had been monitoring developments around a welfare bill in parliament where divisions within the Labour party forced Prime Minister Keir Starmer to back down on large spending cuts, leaving a hole in public finances.

The selloff gathered steam on fears that Reeves would be replaced, but was contained as Starmer gave the finance minister his full backing.

The government has been trying to stick to its self-imposed fiscal rules to try to build investor confidence. However, analysts warn that politically-difficult tax hikes might be needed to balance public accounts and avoid extra borrowing.

"The immediate issue is that the government left a very narrow margin in March against their fiscal rules they set themselves," said a group of analysts led by Jim Reid at Deutsche Bank.

"So unless we got a big burst of growth before the budget, then the government would need to announce further tax rises or spending cuts if they still want to meet the fiscal rules."

Sterling edged up 0.1% to $1.365 after sinking 0.8% in the previous session - its biggest daily drop in more than two weeks. The currency also firmed 0.3% against the euro, which last fetched 86.3 pence.

The relief was also visible in bond markets, where the yield on the 10-year gilt dropped 9 basis points. Yields had spiked on Wednesday, with those on the benchmark note at one point registering their largest one-day jump since October 2022.

Higher yields would generally support the domestic currency, so Wednesday's reaction highlighted investors' pessimism.

Global investors have been grappling with ballooning public debt in developed markets and have also been demanding greater premiums to hold them. Yields on British bonds are among the highest in the developed world.

Wednesday's plunge in British assets immediately drew comparisons with Liz Truss' short-lived premiership in 2022, which was derailed by a bond market selloff.

Traders expect the Bank of England to cut interest rates by 25 basis points again in September, according to data compiled by LSEG.

All eyes will now be on a pivotal U.S. jobs report later in the day that could help gauge the Federal Reserve's monetary policy trajectory.

(Reporting by Johann M CherianEditing by Mark Potter)