The pound was heading for its worst week in 18 months on Friday as City traders anticipated that the UK prime minister, Keir Starmer, could face a challenge from the Manchester mayor, Andy Burnham, later this year.

After days of uncertainty over Starmer’s future, sterling dropped by about three cents, or 2.2%, during the week to $1.332 on Friday, a five-week low. That would be the largest weekly drop against the US dollar since Donald Trump’s election win in early November 2024.

The pound fell against the dollar every day this week as leadership tensions gripped Westminster, culminating in the prospect of Burnham challenging Starmer for the role of PM after the Greater Manchester mayor announced he would run for parliament in the north-west constituency of Makerfield.

“The pound is weakening this morning after a sharp drop on Thursday, when Andy Burnham threw his hat into the ring,” said Kathleen Brooks, the research director at XTB.

“This is a sign that Burnham is the least market-friendly of all the candidates, as Wes Streeting’s resignation did not have the same negative effect,” Brooks added.

UK government borrowing costs jumped, amid a wider sell-off of sovereign debt. The yields on US and German government debt also rose – though the UK rose by more – as a rise in the oil price fuelled inflation worries.

The yield, or interest rate, on UK 10-year bonds jumped to 5.18%, their highest level since 2008 and above the 18-year high set on Tuesday when pressure was mounting on Starmer after last week’s local elections.

Thirty-year bond yields also rose sharply, hitting 5.85%, above the 28-year high reached earlier this week. That is a rise of 20 basis points (0.20 of a percentage point).

The sell-off in UK bonds reflected concerns in the City that a Burnham premiership may loosen the UK’s fiscal rules and increase borrowing to fund higher spending.

Investors remember that in January, Burnham said the UK was “in hock to the bond markets” and trapped in “a low-growth doom-loop”. Burnham has since softened his stance in interviews.

Neil Wilson, an investor strategist at Saxo UK, said markets would not like the idea of the Labour party anointing a left-leaning PM whose fiscal views – and his views of the bond market – were well known.

“Ultimately the bond market is likely to impose fiscal discipline, but it can get messy before that happens. And the UK’s fiscal position gets increasingly fragile every day that the strait of Hormuz is shut,” Wilson added.

Mark Dowding of RBC BlueBay Asset Management told clients that Keir Starmer’s days in 10 Downing Street were “numbered … and against this backdrop UK financial assets and sterling seem likely to be subjected to an elevated political risk premium for an extended period”.

It would take weeks before Burnham is in a position to challenge Starmer, as he must first win a byelection in an area where Reform UK performed well in the local elections, and where the Green party could also contest the seat. The sitting MP, Josh Simons, who is standing down to give Burnham a route back to Westminster, has a majority of just over 5,000 votes.

Bill Diviney, the head of macro research at ABN Amro, predicts that uncertainty and speculation of any changes in fiscal policy are likely to fuel volatility in gilt markets. He added that Burnham was popular with the public.

“Manchester mayor Andy Burnham is by far the most popular among the general public, and in YouGov polling he is actually the only major politician in the UK with a net positive approval rating,” Diviney said.

“A factor that would significantly help is if Rachel Reeves keeps her role as chancellor. This would signal continuity and a commitment to her fiscal rules that have kept markets relatively stable.”