Britain was facing a full blown currency crisis on Friday as the pound went into free fall after Kwasi Kwarteng’s mini Budget.
The value of sterling lurched downwards well over three and a half cents against the dollar during the day to a new 37 year low of $1.0899.
City investors said the markets had lost all faith in the Government’s ability to control the public finances after the Chancellor unveiled a massive tax giveaway.
Financial markets are now pricing in a 20 per cent chance of the pound falling to parity against the dollar for the first time in history, a landmark that would have been considered unthinkable until the last few days.
It is the biggest one day fall since the start of the pandemic in March 2020.
The drop means that British visitors to America will face the worst exchange rate since the pound dropped to a $1.05 in the summer of 1985. The dollar has never been worth more than a pound since it was adopted as America’s currency in 1792.
Equity markets were also particularly downbeat, with the FTSE 100 plunging to its lowest in two months.
“The is the worst day I’ve ever seen in the markets from a British perspective,” said Neil Wilson, an analyst at Markets.com.
It comes after the Bank of England launched another 0.5 percentage point interest rate hike to 2.25% on Thursday and warned the UK could already be in a recession.
The central bank previously projected the economy would grow in the current financial quarter but said it now believes Gross Domestic Product (GDP) will fall by 0.1%, meaning the economy would have seen two consecutive quarters of decline – the technical definition of a recession.
Economists had warned that the Chancellor’s tax-cutting ambitions could put further pressure on the pound, which has also been impacted by strength in the US dollar.
Former Bank of England policy maker Martin Weale cautioned that the new Government’s economic plans will “end in tears” – with a run on the pound in an event similar to what was recorded in 1976.
Economists at ING also warned on Friday that the pound could fall further to 1.10 against the dollar amid difficulties in the gilt market.
Chris Turner, global head of markets at ING, said: “Typically looser fiscal and tighter monetary policy is a positive mix for a currency – if it can be confidently funded.
“Here is the rub – investors have doubts about the UK’s ability to fund this package, hence the gilt underperformance.
“With the Bank of England committed to reducing its gilt portfolio, the prospect of indigestion in the gilt market is a real one and one which should keep sterling vulnerable.”
Lord Nick Macpherson, the former head of the Treasury, said he would not remember a fiscal intervention triggering such a strong response from the market.
He said: “I worked on some 60 fiscal events over 31 years. I can't remember any generating as strong a market reaction as to today's. The £ is currently down over 3% v $, 1.8% v € and 2.5% v ¥. And the cost of borrowing up 40bp at short end and 20bp at long end.”
I worked on some 60 fiscal events over 31 years. I can't remember any generating as strong a market reaction as to today's. The £ is currently down over 3% v $, 1.8% v € and 2.5% v ¥. And the cost of borrowing up 40bp at short end and 20bp at long end. #justsaying https://t.co/EeVWcWAscB
— Nick Macpherson (@nickmacpherson2) September 23, 2022
The pound also moved 1.2% lower against the euro, at 1.133 on Friday.
Meanwhile, concerns over higher interest rates and pressure on consumer spending continued to weigh on the stock market.
The FTSE 100 fell below 7,000 points for the first time in around six months but climbed back to around 7,023 points on Friday afternoon.
Meanwhile, Government gilt yields rocketed amid concerns over the size of the Chancellor’s tax cuts and spending plans.
The 10-year yield jumped around 0.25 percentage points amid a period of heavy selling by nervy traders.