Intro: Sterling hits record low after Kwasi Kwarteng pledges more tax cuts
Good morning and welcome to our continuing coverage of business, the global economy and financial markets.
International confidence in the UK has been hit hard by the Truss government’s mini-budget and tax-cutting policies, and the pound is paying the price.
Sterling had fallen to a record low against the US dollar in Asia-Pacific trade, extending Friday’s losses and moving closer to parity.
Investors have been rattled by the bonanza of tax cuts announced in Kwasi Kwarteng’s mini-budget, with the UK chancellor pledging over the weekend to pursue more tax cuts.
The pound fell nearly 5 percent at one point to $1.0327, Reuters data showed, a record low since at least decimalization in 1971, as belief in the economic management and assets of the United Kingdom evaporated.
Even after stumbling back to $1.05 as City traders hit their desks this morning, the coin was down 7% in two sessions.
It could be a volatile day, with fears of a global downturn also weighing on markets.
Naeem Aslam, chief market analyst at Avatrade, gives a scathing assessment of the situation:
Sterling is taking an absolute beating today in this week’s trading, and traders have picked things up exactly where they left off on Friday.
Sterling looks like an emerging market currency, especially if you look at the price of the British pound a few months ago and compare it to where it is now.
Marc Chandler, chief market strategist at Bannockburn Global Forex, called the currency’s record plunge “unbelievable”. He believes there will certainly be speculation about an emergency Bank of England meeting and a rate hike.
The pound has fallen almost 10% so far this month, hit by anxiety about a looming recession and increased borrowing needed to fund Kwarteng’s £45bn gift.
Yesterday, Kwarteng told BBC One’s Sunday with Laura Kuenssberg that Liz Truss plans to radically reshape the UK economy with even more tax cuts and less regulation.
“There is more to come,” said Kwasi Kwarteng, who declined to set a limit on the amount of public debt that could be incurred in the process.
Chris Weston, head of research at brokerage Pepperstone, said the pound was “the whipping boy” of the G10 currency market, while the UK bond market was ” smoking.”
Weston told customers:
“Investors are looking for an answer from the Bank of England. They say this is not sustainable, when you have deteriorating growth and a double deficit.”
“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.
The City is now watching to see if the Bank of England takes steps to calm the markets.
On Friday afternoon, Deutsche Bank analyst George Saravelos said the BoE would need to carry out a big interest rate hike between meetings this week to calm markets and restore credibility…
Here’s the full story:
the agenda
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09:00 BST: German Ifo Business Climate Index
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1.30pm BST: Chicago Fed National Activity Index on the US economy
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14:00 BST: ECB President Christine Lagarde appears before the European Parliament’s Economic and Monetary Affairs committee in Brussels
Updated at 07.36 BST
Key events
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Key events (9)UK (10)Bank of England (8)Kwasi Kwarteng (5)USA (4)
Bloomberg: Pound-dollar parity looks more likely
Sterling looks increasingly likely to fall to parity against the dollar this year according to options market pricing, Bloomberg has calculated.
Here are the details:
Implied dollar sterling volatility suggests there is a 60% chance it will hit 1.00 before the end of this year, based on spot trading at $1.0552, compared with 32% on Friday.
Markets are also expecting extreme turbulence, with the three-month implied volatility of the sterling dollar rising 4.31 percentage points to 20.05% on Monday. It is fast approaching the high of 20.62% reached during the 2020 pandemic meltdown.
The jump in UK gilt yields is pushing up the cost of borrowing for a decade to a 12-year high, exactly when the British government is planning much more borrowing.
It will be expensive…
Shorting an hour of trading in London and while sterling has clawed back some of its overnight losses, 10-year gilt yields (effectively the interest the government pays on borrowings, of which there will be plenty of more) rose above 4.1%, the highest in 12 years. pic.twitter.com/gLiAvizqUU
— Paul Kelso (@pkelso) September 26, 2022
UK 10-year gilt yield from 1% in January Up 4.2% this morning Debt of £2.4 trillion This is going to be expensive.
— Louise Cooper (@Louiseaileen70) September 26, 2022
Updated at 09.29 BST
Investors ‘inclined to view Tory as doomsday cult’ says analyst
Investors seem inclined to regard the UK Conservative Party as a doomsday cult, according to Paul Donovan, chief economist at UBS Global Wealth Management.
In his morning commentary, Donovan gives an absolutely blistering verdict on the government’s plans:
The global signals from the UK mini-budget are important. Modern monetary theory has been cornered by bond markets and battered. Advanced economy bond yields are not supposed to shoot up in the same way that UK gilt yields did.
This also reminds investors that modern politics produces parties more extreme than the consensus of voters or investors. Investors seem inclined to regard the UK Conservative Party as an apocalyptic cult.
Tax cuts are unlikely to give the UK a significant boost in the medium term (supply constraints in the UK economy are more about health and education). A short-term “sugar high” is likely, but it can be limited. The rational response of a high earner would be to increase savings in anticipation of future tax increases.
El-Erian: Kwarteng should amend the mini-budget to calm the markets
According to Mohamed El-Erian, an adviser to financial services giant Allianz, Chancellor Kwasi Kwarteng is wrong to be relaxed about the market’s reaction to the mini-budget.
El-Erian, who is also president of Queens’ College, Cambridge, says Kwarteng should pay close attention, otherwise “what’s happening in the markets can snowball and undermine what he’s trying to do.”
El-Erian told the Today Program that moves in yields and the pound will translate into “even stronger stagflationary tailwinds,” and that runs counter to Kwarteng’s push for growth.
El-Erian added that the Bank of England would have to raise interest rates by one percentage point if British Finance Minister Kwasi Kwarteng did not ‘recalibrate’ the mini-budget, removing the additional tax cuts that were introduced, which surprise the markets.
If the Chancellor leaves his plans alone, the Bank of England would have to raise interest rates at an emergency meeting. But this also goes against Kwarteng’s plans.
Driving the car with the Chancellor’s foot on the accelerator and the Governor of the Bank’s foot on the brake is not a good way to boost the UK economy, El-Erian warns.
But still, El-Erian says he would raise rates by percentage points, if the chancellor did not change course.
“If I were the governor and the chancellor didn’t change his plan, I would raise interest rates not a little bit, by 100 basis points, by a full percentage point to try to stabilize the situation.”
He also wrote about his concerns for the Guardian today, here:
Updated at 09.33 BST
Economist Shaun Richards suggests the Bank of England should halt its plan to start selling some of its British gold holdings.
The BoE has decided to start unwinding its quantitative easing (QE) program by selling £80 billion over the next few months. This, however, will increase selling pressure in the bond market.
Putting Quantitative Tightening (QT) on hold could calm markets…
There is a lot of talk about the intervention of the Bank of England but in the wrong market! With the UK 10-year yield at 4.1%, it would have to scrap the £80bn bond sales plan or active QT. That would calm things down…
— Shaun Richards (@notayesmansecon) September 26, 2022
…. and they are certainly far from quiet now as the UK golds are being shipped:
Shadow Chancellor Rachel Reeves has accused Kwasi Kwarteng of “fanning the flames” of the pound’s fall by hinting at further “unfunded” tax cuts.
Reeves told BBC Radio 4’s Today programme:
“It’s incredibly worrying.
“I think a lot of people expected things to calm down over the weekend, but I think the Chancellor fanned the flames on Sunday by suggesting there could be more stimulus, more unfunded tax cuts, which he has that the pound fell overnight to a record low against the dollar.”
UK bonds continue to fall, pushing yields even higher.
The two-year gilt yield (which measures short-term borrowing costs) has reached 4.5%, double its level in mid-August.
At 4.5%, the 2-year UK Gilt yield is back to October 2008 levels after spending a decade below 1%. This is not an isolated incident, after Italy’s BTPs pic.twitter.com/dbthkbTvTV
— Rich Kleinbauer (@RMKOutFront) September 26, 2022
Here’s the take from Reuters:
British government bond prices collapsed in early trading on Monday after sterling hit a record low against the US dollar overnight, pushing yields to their highest in more than a decade
Five-year gilt yields rose more than 40 basis points to 4.503%, their highest since October 2008, while two-year yields rose more than 50 basis points to 4.533% from of September 2008.
Government borrowing costs rise more than 4% as bond prices fall
UK government bonds are selling off sharply in early trading, again adding to Friday’s losses immediately after the mini-budget.
The yield, or interest rate, on British two-, five- and ten-year gilts has risen dramatically.
Yields (which rise when prices fall) measure the bond’s interest rate -…