Borrowing costs for the UK government fell on Monday as former chancellor Rishi Sunak became the favourite to replace Liz Truss as prime minister.
The pound also rose against the dollar initially, before falling back below $1.13.
Mr Sunak is currently the only candidate backed by more than 100 Tory MPs, the level required to take part in the ballot of party members.
Former PM Boris Johnson dropped out of the contest on Sunday.
Commons leader Penny Mordaunt remains in the race but is some way off securing 100 backers according to a BBC tally of MPs who have publicly declared their intentions.
The deadline is 14:00 BST on Monday.
Last month, sterling plunged to a record low against the dollar and government borrowing costs rose sharply in the aftermath of outgoing Prime Minister Liz Truss’s mini-budget.
Investors were spooked after then-Chancellor Kwasi Kwarteng promised major tax cuts without saying how they would be paid for – something Mr Sunak warned about during this summer’s Tory leadership contest.
Last week, new Chancellor Jeremy Hunt withdrew almost all of Ms Truss’s tax cuts in a bid to stabilise the financial markets but they have remained jittery.
On Friday, the pound fell as low as $1.11 and government borrowing costs rose amid continued political uncertainty and fresh warnings about the UK economy.
On Monday, government borrowing costs fell back. The interest rate – or yield – on bonds due to be repaid in 30 years’ time dropped to 3.8%. The rate had hit 5.17% on 28 September after the mini-budget and a subsequent pledge by Mr Kwarteng to announce more tax cuts.
Mr Hunt – who is backing Mr Sunak – is scheduled to set out the government’s economic plan for taxes and spending on 31 October.
He has warned the government is facing “decisions of eye-watering difficulty”.
But on Monday, financier and long-term Tory supporter Guy Hands said the Conservative Party was not fit to run the country and risked having to ask the International Monetary Fund (IMF) for a bailout.
“I think it’s got to move on from fighting its own internal wars and actually focus on what needs to be done in economy, and admitting some of the mistakes they’ve made in the last six years which have frankly put this country on a path to be the sick man of Europe,” said Mr Hands.
He warned that the UK was headed for higher taxes, reduced public services and higher interest rates which would “eventually” lead to a bailout from the IMF “like we were in the 70s”.
At the weekend, the former governor Bank of England warned that the UK is facing a “more difficult” era of austerity than the one after the 2008 financial crisis in order to stabilise the economy.
Lord Mervyn King said the average person could face “significantly higher taxes” to fund public spending.
Megan Greene, a global chief economist at the Kroll Institute consultancy, told the BBC’s Today programme that while Mr Sunak’s position as the frontrunner “should help” calm the markets: “The UK has a really tough line to walk.”
“On the one hand it can’t provide these budgets that are fiscally irresponsible, or that seem fiscally irresponsible, we’ve seen what happens with the market then, but equally Rishi Sunak is going to come and probably announce a lot of austerity and he can’t go too far on that end either because then the markets will look at that and think the UK is never going to grow.
“Even without all the political drama, the economic environment in the UK is incredibly difficult.”
A fall in the value of the pound increases the price of goods and services imported into the UK from overseas – because when the pound is weak against the dollar or euro, for example, it costs more for companies in the UK to buy things such as food, raw materials or parts from abroad.
If businesses pass on those higher costs to customers, a weaker pound can help push up inflation – the rate at which prices rise.
Also, for Britons travelling overseas, changes in the pound’s value affect how far their money will go abroad.
Sterling has also been under pressure recently due the strength of the US dollar.
However, the pound’s weakness in recent weeks has been most tied to mounting concerns about the outlook for the UK’s economy and public finances.
The official rate of inflation rose to 10.1% last month and is expected to climb further.
The UK is also borrowing billions of pounds to limit energy bill rises for households and businesses.
Borrowing – the difference between spending and tax income – was £20bn in September, up £2.2bn from a year earlier, the Office for National Statistics said.
It was the second highest September borrowing since monthly records began in 1993.
The Institute for Fiscal Studies think tank predicted borrowing this year could reach £194bn, almost double the figure previously forecast by The Office For Budget Responsibility.(BBC)
