Odds of sterling hitting parity with dollar jump, as analysts say UK bond market ‘getting smoked’ by giveaway
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, a
news report says.
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, according to the report in the Guardian. 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.
According to the Guardian report, 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.
Whipping boy
“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.”
The report cites Marc Chandler, chief market strategist at
Bannockburn Global Forex, as saying the currency’s record plunge is “incredible”
and saying there was bound to be speculation of an emergency Bank of England
meeting and rate hike.
‘Getting smoked’
Chris Weston, the head of research at the brokerage firm
Pepperstone, said the pound was “the whipping boy” of the G10 foreign exchange
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 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.
Inflationary pressures
“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
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.
Investment position
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 monetize the debt, rather than
offsetting the fiscal stimulus with tighter monetary policy.
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.
Import costs
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
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,” the report said.
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