The Bank of England and the UK Treasury battled to calm market turmoil on Monday after the pound hit a record high against the US dollar, but sterling suffered another wave of selloffs as investors concerned about the sustainability of public finances.
On a day when the pound hit an early morning low of $1.035, the BoE issued a statement saying it would “not hesitate to change interest rates” to keep inflation in check.
But his announcement that he did not intend to carry out a “full assessment” of the British government’s controversial new debt-fueled economic policy before its next meeting scheduled for November, has raised further concerns.
The statement dashed market hopes of an emergency BoE rate hike to support the pound. The currency quickly fell below $1.07 from its daily high of $1.0931. UK government bonds remained under heavy selling pressure.
Meanwhile, Kwasi Kwarteng, Chancellor, tried to calm the markets in a statement – coordinated with the BoE – in which he pledged to accelerate the development of a new strategy to bring debt under control.
Kwarteng told the Financial Times on Friday that he would draw up a new medium-term budget plan “in the new year”. Instead, he will outline the new strategy to put debt on a downward path on November 23.
He also tried to reassure markets by announcing an independent set of forecasts by the Office for Budget Responsibility on the same day; a new budget will take place next spring.
The statements follow intense talks between Kwarteng and BoE Governor Andrew Bailey following the Chancellor’s new budget plan, which combines £45billion in tax cuts with a massive wave of new borrowing .
The bank said it “would not hesitate to change interest rates if necessary to bring inflation back to the 2% target on a sustainable basis over the medium term, in line with its mandate.”
But he added that his action would only come after “a full assessment at its next scheduled meeting of the impact on demand and inflation of government announcements”.
Asked whether the UK’s new fiscal plan has increased economic uncertainty and increased the chances of a global recession, Raphael Bostic, chairman of the Atlanta branch of the US Federal Reserve, said: “It doesn’t ‘not help’.
The OBR’s economic forecast is expected to show underlying public debt on a steadily rising trajectory following Kwarteng’s decision to implement the biggest tax cuts since 1972 and when the cost of borrowing government increases sharply.
In a bid to show fiscal responsibility, the Treasury has confirmed it will stick to the government’s current spending plans – which extend beyond 2024, when the next election is due.
Traders unwound their bets on an unforeseen shift to higher rates, but got stuck on their bets on an extra-wide rise at the next central bank meeting. After the BoE’s announcement, markets were expecting a rise of 1.5 percentage points to 3.75% in November. The bank rate should reach nearly 6% by May.
The pound’s trade on Monday was the most turbulent since the depths of the coronavirus crisis in 2020, with the currency seeing a swing of more than 5% between its highs and lows for the day.
Early in the morning, the pound fell as much as 4.7% to trade at $1.035 to the dollar after Kwarteng pledged over the weekend to continue its tax cut campaign.
“The UK is now in the midst of a currency crisis,” said Vasileios Gkionakis, head of foreign exchange strategy at Citigroup Emea.
Britain’s government debt fell further on Monday after Friday’s sharp selloff, the worst day for the gilt market since the early 1990s.
The 10-year gilt fell sharply, pushing yields up 0.42 percentage points to 4.2% from around 3.5% before Friday’s budget announcement. Two-year yields, particularly sensitive to BoE expectations, jumped to 4.5% from 3% at the end of August.
“It looks like we’re headed for a spiral that we usually see in emerging market crises, where policymakers struggle to reassert their credibility,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore. He pointed out that the country still had a “gaping current account deficit”.
Additional reporting by Jim Pickard in Liverpool, and Stephanie Findlay and Hudson Lockett in Hong Kong, Adam Samson in New York and Leo Lewis in Tokyo