Pound hits all-time low after mini-budget rocks markets

The pound has hit an all-time 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.

The pound plunged nearly 5% at one point to $1.0327, breaking below 1985 lows as belief in Britain’s economic management and assets evaporated. Even after stumbling back to $1.05, the currency was down 7% in two sessions.

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.”

Marc Chandler, chief market strategist at Bannockburn Global Forex, called the currency’s record plunge “incredible” and said there was bound to be speculation of an emergency Bank of England meeting and rate hike.

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 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.

“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 balance and the net 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.

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 monetise 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.

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 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 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.”