The pound slumped against the euro and dipped versus the dollar on Monday as traders reacted to the crisis ‍facing Prime Minister Sir ‍Keir Starmer and as expectations of further interest rate cuts weighed on the currency.

Morgan McSweeney, Starmer's chief of ​staff, quit on Sunday, saying he took responsibility for advising the Prime Minister to choose Peter Mandelson as ambassador to the U.S. despite his known ⁠links to Jeffrey Epstein.

Yet Starmer remains under pressure, with the Epstein saga far from over and tough local elections looming. The euro was last ⁠up ‌0.49% against the pound at 87.22 pence.

That was around a two-week high, though the euro remains flat against sterling this year. Against the dollar, the pound was a touch lower at $1.3607 after falling as much as 0.2% ⁠earlier in the session.

POLITICS IN FOCUS FOR UK ASSETS

British government bonds also slightly underperformed their European peers on Monday as markets focused on Starmer's situation, although the moves were muted.

Many bond investors worry a new Labour prime minister would shift policies to the left and increase spending, while currency markets traditionally abhor political instability. The government now faces the potentially embarrassing ⁠release of almost all private communications between officials ​about Mandelson's appointment.

An election for a parliamentary seat in Manchester later this month and local elections in May could deal another blow to Starmer's leadership.

"Expect pressure to remain ‍on both sterling and gilts as the market speculates over a change of personnel at numbers 10 and 11 Downing Street," said Chris Turner, head of global ​markets at lender ING, referring to the addresses of the prime minister and finance minister.

"Combined with a dovish twist at last week's Bank of England meeting, sterling is under pressure."

RATE CUT BETS DIVERGE

The pound was also feeling the effects of a closer-than-expected Bank of England decision to hold interest rates last week, which caused traders to ramp up bets on further cuts this year.

The European Central Bank meanwhile seems likely to keep rates steady for the foreseeable future, with the expectations of lower relative returns denting the appeal of the pound versus the euro.

"The pound looks set to continue trending weaker across the board," said Neil Jones, managing director for FX sales and trading at TJM Europe.

"Political uncertainty is on the increase." Three-month risk reversals, which show the difference between the cost of owning ⁠an option to buy the euro against the pound versus the cost of ‌one to sell the euro against sterling, rose to 67 basis points, the highest since late November, from a low of 22 bps on Thursday. The higher the number, the more bullish sentiment is for the euro versus sterling and vice versa.

The euro was also ‌up around 0.4% ⁠against the dollar on Monday. Some analysts said a Bloomberg report that China has advised banks to limit their holdings of U.S. Treasuries ⁠was weighing on the dollar.

(Reporting by Harry Robertson; Additional reporting by Amanda Cooper; Editing by Emelia Sithole-Matarise)