Pound falls below $1.09 for first time since 1985 after mini-budget | Sterling

Written by

The pound fell below $1.09 on Friday for the first time since 1985 as investors spooked at the prospect of a rise in government borrowing to pay for the sweeping tax cuts in Kwasi Kwarteng’s mini-budget.

After delivering a scathing verdict on the chancellor’s “round the clock for growth”, traders sent the pound tumbling on Friday in a broad-based sell-off in response to the huge increase in government borrowing required to fund his plans.

The cost of UK government bonds rose the most in a single day in at least a decade, while the currency meltdown fueled speculation. Bank of England would be forced to launch an emergency rate hike to repair Britain’s battered credibility with global investors.

Analysts at Deutsche Bank said the sell-off showed investors were “no longer willing to finance the UK’s external deficit position in the current configuration”, while adding: “The political response required to what is going on is clear: a large, inter-meeting interest rate increase from the Bank of England as early as next week to regain credibility with the market.”

US investment bank JPMorgan said it revealed “a wider loss of investor confidence in the government’s approach”, while Citi said the Chancellor’s tax handout, the largest since 1972 risked “a crisis of confidence in sterling”.

The pound fell three-and-a-half cents against the dollar to a fresh 37-year low, trading below $1.09, as fears over the future path of public finances also triggered a rise in government borrowing costs. The fall came after the chancellor announced £45bn of tax cuts aimed at higher wage earners.

“I worked on about 60 financial events over 31 years. I can’t remember any generating such a strong market reaction as today,” said Nick Macpherson, the former permanent secretary to the Treasury under three chancellors.

When asked about the drop in sterling on a visit to Kent after the mini-budget, Kwarteng said: “I don’t comment on market movements.”

pound falls

On a day of heavy selling pressure across global financial markets FTSE 100 ended the day down 2%, recovering from falling below 7,000 earlier in the day for the first time since early March, following Russia’s invasion of Ukraine.

Two-year UK government bond yields – which are inversely related to the value of bonds and rise as they fall – jumped by as much as 0.4 percentage point to close to 4%, hitting the highest level since the 2008 financial crisis.

The yield on 10-year bonds rose more than 0.2 percentage point to close to 3.8%, continuing a dramatic rise underway since Liz Truss took office as prime minister earlier this month. At the start of September, interest rates on benchmark UK government debt have risen by almost a percentage point, significantly more than for comparable advanced economies.

Financial industry executives said UK assets fell by a much greater extent than comparable leading economies.

Larry Summers, the former US Treasury chief, said he would not be surprised if the pound fell below parity with the dollar if the Truss government continues on its current path. “The UK is behaving like an emerging market turning itself into an underwater market,” he told Bloomberg TV.

“[It’s] really hard to overstate the extent to which the Kwarteng budget has just destroyed the gilt market,” said Toby Nangle, a former fund manager at Columbia Threadneedle. To illustrate the extent of the turmoil, he said five-year gilt yields had moved the most in a single day since 1993 – surpassing the Covid pandemic, the 2008 financial crisis and 9/11.

Britain’s experiment with Trussonomics comes at a challenging time, with the US dollar strengthening in international markets, major central banks raising interest rates and advanced economies around the world facing rising borrowing costs due to lower growth and rising inflation.

However, investors said Britain was singled out after several years in which the government had damaged its reputation for sound economic management, exacerbated by the steps taken by the new prime minister.

Gabriele Foa, a portfolio manager at Algebris Investments, said Britain had lost “a lot of credibility” and had “pushed the market’s patience” through a series of economic missteps.

“[It’s about] Covid management, government instability, Brexit management. It’s just a big, let’s say, series of concerns. Great Britain was in the first league, [but] it moves from first, to second, to third. If you show any signs that you’re not reliable, you move leagues.”

To fund the Chancellor’s tax cuts and energy price guarantee, the Treasury said it would need to issue £72.4bn. in additional UK government bonds to investors this financial year, bringing the total to £234.1bn. in 2022-23.

It is happening at a time when the Bank of England is also selling 80 billion. pound in the gilts held on its balance sheet built up under its quantitative easing program, adding to the large volume of government bonds sold to investors.

Markets are betting that the bank would be forced to raise interest rates above 5% next May – more than double the current rate of 2.25% – amid expectations that Kwarteng’s tax cuts would add significantly to inflationary pressures.

Vivek Paul, UK chief investment strategist at BlackRock Investment Institute, said: “The credibility of the UK is what the markets are reacting to.

“Over time, we will know whether there will be a fundamental change. The jury is out [but] the initial reaction from the markets is not a ringing endorsement. Let’s put it this way.”

About the author

Leave a Comment