Sterling Hits Record Low Against The Dollar After Mini-Budget Rocks Markets
After Kwasi Kwarteng’s Mini-Avalanche-Budget of Tax Cuts And Expenditure Initiatives Threatens to Erode Trust in The UK The Pound Fell to an All-Time Low Versus The Dollar
Pound sterling fell to $1.0327 at one time, its lowest level since 1971, when Britain adopted the decimal system, as confidence in the UK’s economic management and assets vanished. 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 experts claimed the collapse in the pound may drive the Bank of England into an emergency interest rate hike to stabilise the currency.
Capital Economics senior UK economist, Paul Dales, stated that the Bank might provide “tough talk” backed by a significant and quick interest rate increase.
“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 market’s response to the mini-budget has the shadow chancellor, Rachel Reeves, “incredibly worried”, according to Times Radio.
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.”
The currency’s record decline was “incredible,” according to Bannockburn Global Forex’s chief market strategist Marc Chandler, who also predicted that there would be rumours of an emergency Bank of England meeting and rate rise.
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.
Kwarteng’s mini-budget on Friday sent the UK stock market to its knees. Sterling dropped four cents to $1.0856, the lowest level in 37 years, as the cost of government borrowing increased by the most 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.
Earlier this year, the UK’s current account deficit—which takes into account the trade balance as well as net income from foreign investment and transfers—had already grown to a record high. The increase in the price of imported energy is contributing to this deficit, which is driving the pound toward levels where UK assets are once more appealing to international investors.
Bloomberg’s options pricing model indicated on Friday afternoon that there was a 26% possibility that the pound and the dollar will reach parity over the next six months, up from a 14% likelihood on Thursday.
The economist Nouriel Roubini, who foresaw the 2008 financial crisis, ominously stated that the UK was beginning to be priced like an emerging market and was returning to the 1970s.
“Stagflation and eventually the need to go and beg for an IMF bailout … Truss and her cabinet are clueless,” he tweeted.
However, Paul Krugman, a Nobel economics laureate, argued that the pound’s decline actually strengthened Britain’s net position in foreign investments.
According to Krugman, a sterling crisis such as that of the 1970s is improbable unless the Bank of England decides to monetize the debt rather than counteracting the fiscal stimulus with tighter monetary policy.
Kwarteng stated on BBC One’s Sunday with Laura Kuenssberg that he was focused on promoting longer-term growth, not on short-term market movements, in an effort to downplay the financial response to Friday’s mini-budget.
“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.
Liz Truss intends to drastically alter the UK economy with even more significant tax cuts and fewer regulations, according to Kwarteng.
Because a weaker pound raises import prices, the Bank of England is anticipated to hike interest rates further to counteract the inflationary effects of the mini-budget. By the summer of next year, the money markets anticipate a doubling of UK interest rates to more than 5%.
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 dropped 2% on Friday, finishing at a three-month low. The blue-chip index has lost 5% so far this year, which is far less than the US or European markets thanks to exporters who have benefited from the cheap pound and oil companies.
“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.”
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