The pound has hit a new 37-year low after the bonanza of tax cuts and spending measures in Kwasi Kwarteng’s mini-budget threatened to undermine confidence in the UK.
Sterling fell to $1.077 in early trade as Asia-Pacific markets opened after the weekend, closer to parity with the US dollar.
Chris Weston, head of research at brokerage Pepperstone, said the pound was the “hand boy” of the G10 currency market, while the UK bond market was “smoking ” thanks to Kwarteng’s £45bn tax cut. package
“The funding requirement needed to pay the mini-budget means we need to see much better growth or higher bond yields to incentivize capital inflows,” Weston said. Targets that the pound could fall below $1.05 for the first time were being “liberally thrown around”, he added.
After such a dramatic week in the markets, we expect a huge week of central bank speakers – will they risk the rally or will the markets chase a response as the ability to price risk is so uncertain?
Some thoughts on the trade landscape and the big talking points #trading #market #USD pic.twitter.com/vUUUR1ig6b
— Chris Weston (@ChrisWeston_PS) September 25, 2022
Kwarteng’s mini-budget sent UK financial markets tumbling on Friday. Sterling lost 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.
Sterling falls against the US dollar
“The price of easy fiscal policy was exposed by the market,” said Sanjay Raja, chief UK economist at Deutsche Bank. He said Kwarteng’s tax cuts add to medium-term inflationary pressures and “increase the risk of a short-term balance of payments crisis”.
“A plan to make public finances sustainable will be necessary, but not sufficient, for markets to regain confidence in an economy with large twin deficits,” Raja said.
The UK’s current account deficit, which includes the trade balance and net income from investment and foreign transfers, had already widened to a record level this year. The jump in the cost of imported energy is adding to this shortfall, which is pushing the pound towards levels that are once again making UK assets attractive to overseas buyers.
On Friday afternoon, the Bloomberg Options Pricing Model showed there was a 26% chance of the pound and dollar hitting parity over the next six months, compared with 14% on Thursday.
UK currency and bond markets fell…GBP lowest since 1985 “According to Bloomberg’s options pricing model, the pound has a 26% chance of hitting parity against 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, bluntly warned that the UK was beginning to be priced as an emerging market and returning to the 1970s.
“Stagflation and finally the need to go for an IMF bailout…Truss and his cabinet are clueless,” he tweeted.
But Paul Krugman, a Nobel laureate in economics, pointed out that the depreciation of the pound actually improved the UK’s net international investment position.
Krugman said a 1970s-style sterling crisis is unlikely unless the Bank of England chooses to monetize debt, rather than offsetting fiscal stimulus with tighter monetary policy .
Sign up for Business Today
Get ready for the workday – we’ll tell you all the business news and analysis you need every morning
Privacy Notice: Newsletters may contain information about charities, online advertisements and content funded by third parties. For more information see our Privacy Policy. We use Google reCaptcha to protect our website and Google’s Privacy Policy and Terms of Service apply.
I’ve had emails from City economists who agree that balance sheet effects won’t be a problem, but are concerned that the BoE won’t actually offset the fiscal stimulus, which will monetize deficits 1/ https: //t.co/2ybbKV1Suo
— Paul Krugman (@paulkrugman) September 25, 2022
Kwarteng tried to play down the financial backlash to Friday’s mini-budget, telling BBC One’s Sunday with Laura Kuenssberg that he was focused on boosting long-term growth, not short-term market moves.
“As Chancellor of the Exchequer, I do not comment on market movements. What I’m focused on is growing the economy and making sure Britain is an attractive place to invest,” he said.
The Bank of England is expected to raise interest rates higher to combat the inflationary impact of the mini-budget as the weakening pound pushes up import costs. Money markets are pricing in a doubling of UK interest rates to more than 5% next summer.
“Tory MPs are wondering whether Mr Kwarteng has been brilliant or crazy. The markets are saying crazy,” said David Blanchflower, a former member of the Bank’s monetary policy committee.
Blanchflower said he feared Kwarteng’s “reckless attitude” could encourage investors to “keep selling UK plc”.
After the mini-budget, the UK Debt Management Office plans to raise an extra £72bn before next April, raising the funding charge in 2022-23 to £234bn.
“Sterling is in the firing line as traders are turning their backs on all things British,” said David Madden, market analyst at Equity Capital. “There is a growing sense that the additional government borrowing that is being considered will seriously affect the UK economy.”
The FTSE 100 fell 2% to a three-month closing low on Friday. So far this year, the index of top-tier companies has lost 5%, far less than the European or US markets, helped by oil companies and exporters boosted by the weak pound.
“The chancellor’s high-risk strategy could lead to a bigger correction in the FTSE 100 before the year is out,” said Charles Archer, financial writer at online trading platform IG. “As monetary policy tightens, mortgages and debt defaults rise, while growth investment falls. This could render the mini-budget totally ineffective.”