MUFG: UK Politics - FJElite

The pound continues to trade on a softer footing this morning despite evidence revealing that the UK economy expanded more robustly than expected at the start of this year. The latest UK GDP report revealed that the economy expanded by 0.6% in Q1 up from an upwardly revised expansion of 0.2% in Q4 2025. It was the fastest quarter of growth since Q1 of last year. It fits with the pattern in recent years whereby the economy has started strongly then slowed through the rest of the year. Slower growth in the coming quarters appears likely again in response to the energy price shock. On the plus side the UK economy had stronger growth momentum heading into the shock with growth driven by private consumption which expanded by 0.6% and business investment which expanded by 0.7%. Stronger UK cyclical momentum alongside higher UK yields and favourable conditions for carry trades have helped to the pound to surprisingly outperform so far during the Middle East conflict.

However, downside risks for the pound have increased in the near-term in response to heightened political uncertainty in the UK. It has been reported that Prime Minister Keir Starmer could face a leadership challenge as soon as today. Health Secretary Wes Streeting is reportedly set to quit his post this week and launch a bid to replace Starmer as leader of the Labour party. It is not yet clear if he has the backing of 81 MPs required to launch a formal leadership challenge. At the same time, it has been reported that Angela Rayner has been cleared in an investigation into whether she deliberately dodged paying tax which paves the way for her to launch her own leadership campaign. However, recent comments from Angela Rayner have indicated that she favours supporting Manchester mayor Andy Burnham as a potential leader, and would only run on her won if he is unable to take part.

Once a leadership contest is triggered, other candidates could join if they also have 81 backers. Labour party members and affiliate members then vote by postal ballot to choose the new leader. A recent survey carried out by Survation between 30m April and 5'" May revealed that Andy Burnham is by far the most popular potential candidate amongst Labour members followed by other soft left candidates Angela Rayner and Ed Miliband. The survey indicates that a soft left Labour candidate is mostly likely to replace Keir Stamer if a leadership contest takes place which would create more unease over UK fiscal risks weighing on gilts and the pound.