The pound has hit an all-time low against the dollar after the bonanza of tax cuts and spending measures in Kwasi Kwarteng’s mini-budget threatened to undermine confidence in the UK.
The pound plunged nearly 5% at one point to $1.0327, its lowest since Britain went decimal in 1971, as belief in the UK’s economic management and assets evaporated. Even after stumbling back to $1.05, the currency was down 7% in two sessions, after the UK chancellor pledged over the weekend to pursue more tax cuts.
City economists suggested the slump in the pound could force the Bank of England into an emergency interest rate rise to support the currency.
Paul Dales, the chief UK economist at Capital Economics, said the Bank could come out with “tough talk” supported by a large and immediate interest rate hike.
“That could involve something like a 100bps or 150bps hike in interest rates (to 3.25%/3.75%), perhaps as soon as this morning,” Dales told clients.
The shadow chancellor, Rachel Reeves, told Times Radio she was “incredibly worried” by the market reaction to the mini-budget.
As Asia-Pacific markets opened on Monday, Ray Attrill, National Australia Bank’s head of currency strategy, said: “It’s a case of shoot first and ask questions later, as far as UK assets are concerned.”
Marc Chandler, chief market strategist at Bannockburn Global Forex, called the currency’s record plunge “incredible” and said there was bound to be speculation of an emergency Bank of England meeting and rate hike.
Chris Weston, the head of research at the brokerage firm Pepperstone, said the pound was “the whipping boy” of the G10 foreign exchange market, while the UK bond market was “getting smoked” thanks to Kwarteng’s £45bn debt-financed tax-cutting package.
“Investors are searching out a response from the Bank of England. They’re saying this is not sustainable, when you’ve got deteriorating growth and a twin deficit.”
“The funding requirement needed to pay for the mini-budget means either we need to see far better growth or higher bond yields to incentive capital inflows,” Weston said.
Not a promising start to the week for sterling in Asian trading: a new low versus the dollar below $1.0770, down about 0.8% from Friday pic.twitter.com/WjvElpLipN
— David Milliken (@david_milliken) September 25, 2022
The pound is in free fall. It hits a new record low and is quickly heading toward parity with the US dollar. pic.twitter.com/bRjZgY1xoT
— Lisa Abramowicz (@lisaabramowicz1) September 26, 2022
Kwarteng’s mini-budget caused a rout in UK financial markets on Friday. Sterling shed four cents to hit a 37-year low of $1.0856, while the jump in the cost of government borrowing was the biggest in a single day in decades.
“The price of easy fiscal policy was laid bare by the market,” said Sanjay Raja, chief UK economist at Deutsche Bank. He said Kwarteng’s tax cuts were adding to medium-term inflationary pressures and were “raising the risk of a near-term balance of payments crisis”.
“A plan to get the public finances on a sustainable footing will be necessary but not sufficient for markets to regain confidence in an economy sporting large twin deficits,” Raja said.
The UK current account deficit, which includes the trade balance and the net income from foreign investment and transfers, had already widened to a record level this year. The jump in the cost of imported energy is adding to this deficit, which is pushing the pound down towards levels that make UK assets attractive to foreign buyers again.
On Friday afternoon, Bloomberg’s options pricing model showed there was a 26% chance the pound and the dollar hitting parity within the next six months, up from 14% on Thursday.
UK FX and bond markets crashed...
GBP lowest since 1985
"According to Bloomberg’s options pricing model, the pound holds a 26% chance of touching parity versus the greenback in the next six months..." pic.twitter.com/1HvC2uPKYM
— Caroline Hyde (@CarolineHydeTV) September 23, 2022
Nouriel Roubini, the economist who predicted the 2008 financial crisis, warned bluntly that the UK was starting to be priced like an emerging market, and was heading back to the 1970s.
“Stagflation and eventually the need to go and beg for an IMF bailout … Truss and her cabinet are clueless,” he tweeted.
But Paul Krugman, a Nobel economics laureate, pointed out that the pound’s depreciation actually improved Britain’s net international investment position.
Krugman said a 1970s-style sterling crisis was unlikely to occur unless the Bank of England chooses to monetise the debt, rather than offsetting the fiscal stimulus with tighter monetary policy.
I've been getting emails from City economists who agree that balance sheet effects won't be a problem, but are worried that the BoE will not, in fact, offset the fiscal stimulus — that it will in effect monetize deficits 1/ https://t.co/2ybbKV1Suo
— Paul Krugman (@paulkrugman) September 25, 2022
Kwarteng tried to play down the financial reaction to Friday’s mini-budget, telling BBC One’s Sunday with Laura Kuenssberg he was focused on boosting longer-term growth, not on short-term market moves,
“As chancellor of the exchequer, I don’t comment on market movements. What I am focused on is growing the economy and making sure that Britain is an attractive place to invest,” he said.
Kwarteng also indicated that Liz Truss plans to radically reshape the UK economy with even more tax cuts and fewer regulations.
The Bank of England is expected to raise interest rates higher to combat the inflationary impact of the mini-budget, as a weakening pound drives up costs of imports. The money markets are pricing a doubling of UK interest rates to more than 5% by next summer.
After the mini-budget, the UK Debt Management Office plans to raise an additional £72bn before next April, raising the financing remit in 2022-23 to £234bn.
“Sterling is in the firing line as traders are turning their backs on all things British,” said David Madden, a market analyst at Equiti Capital. “There is a creeping feeling the extra government borrowing that is in the pipeline will severely weigh on the UK economy.”
The FTSE 100 tumbled 2% to a three-month closing low on Friday. So far this year, the index of blue-chip companies has lost 5% – much less than European or US markets – helped by oil companies, and exporters boosted by the weak pound.
“The chancellor’s high-risk strategy could entail a larger FTSE 100 correction before the year is out,” said Charles Archer, a financial writer at online trading platform IG. “As monetary policy tightens, mortgage and debt defaults rise, while investment in growth falls. This could render the mini-budget entirely ineffective.”