The pound fell to a record high on Monday, sparking expectations of an emergency UK interest rate hike following Chancellor Kwasi Kwarteng’s tax cut package last week.
The currency lost as much as 4.7% to trade at $1.035 early in the morning before stabilizing around $1.07. The turmoil came after Kwarteng vowed at the weekend to stick to his tax cut campaign, sparking warnings the UK was entering a currency crisis.
The onset of autumn took the pound to its lowest level since the current system of floating currencies began in 1971. It sharpened criticism of Friday’s budget statement, when the Chancellor announced a massive new wave of borrowing to fund £45billion in tax cuts and a package to curb rising energy bills.
“The UK is now in the midst of a currency crisis,” said Vasileios Gkionakis, Citigroup’s head of foreign exchange strategy.
The pound also fell 3.7% against the euro on Monday to €1.0787, hitting its lowest level since September 2020.
Traders increased bets on an emergency interest rate hike ahead of the next Bank of England meeting in November. Derivatives markets are anticipating a rise of more than 0.5 percentage points in a week and an increase of almost 1.5 percentage points by the November meeting.
The central bank declined to say whether it was planning an emergency interest rate meeting this week.
The Treasury did not comment on market movements on Monday. Kwarteng told the Financial Times in an interview last week: “I’m still calm. Markets move all the time. It is very important to keep calm and focus on the longer term strategy.
The UK lacks the resources, and probably also the will, to try to intervene directly in the currency markets to support the pound, unlike its peers in Japan, who intervened last week. However, the BoE’s monetary policy committee has met outside of the normal cycle when markets have been turbulent in the past in an attempt to restore calm, usually by cutting rates. Since gaining independence in 1997, the BoE has never raised rates between scheduled meetings.
Sushil Wadhwani, asset manager and former BoE policymaker, said: “If I was still at the BoE, I would be tempted to announce an additional meeting in a week.”
Britain’s government debt continued to fall on Monday after Friday’s sharp selloff, the worst day for the gilt market since the early 1990s.
The yield on the 10-year gilt, which rises as prices fall, climbed 0.23 percentage points to 4.06% from around 3.5% before Friday’s budget announcement. The pound had weakened to its lowest point since 1985 on Friday, below $1.09 – a level it broke above on Monday.
The Westminster tax cuts come as the UK is already set to spend £150billion to subsidize energy costs for consumers and businesses. A large part of these borrowings must be financed by gilts.
Unlike the deep tax cuts of the 1980s, Kwarteng is borrowing tens of billions of pounds to fund its plans, adding to demand at a time when the BoE is raising rates to tame inflation.
“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.
Mohi-uddin said investor confidence in the pound had been undermined by expectations that Britain’s public debt was now on an “unsustainable upward path” as the country still posted a “gaping current account deficit”.
“If we continue to see these huge movements in the market, the Bank of England will have to raise interest rates, perhaps up to 1 percentage point, to try to stabilize the pound,” he said. added.
The Bank of England raised interest rates by 0.5 percentage points on Thursday, following a third straight increase of 0.75 percentage points by the US Federal Reserve a day earlier.
“We had argued that the way forward for the pound would depend heavily on the monetary response to near-term inflation and well-targeted fiscal measures, but so far delivery has been less than encouraging on the two fronts,” FX analysts at Goldman Sachs said.
“With large unfunded fiscal spending without a monetary policy counterpart to offset the inflationary impulse, the currency is likely to weaken further.”
Rachel Reeves, shadow chancellor, said Kwarteng ‘fanned the flames on Sunday by suggesting there could be more stimulus, more unfunded tax cuts’.
Reeves, a former economist at the Bank of England, said rising interest rates were making the cost of living worse for households.
“The Prime Minister and the Chancellor are like two gamblers in a casino chasing after a losing race…they don’t gamble their money, they gamble all our money,” she told the Today program. BBC Radio 4. “I say this is irresponsible, reckless and grossly unfair.”
Labor promised to roll back some of Friday’s mini-budget tax cuts – on national insurance, corporation tax and the scrapping of the 45p rate – but would keep the impending tax cut on based on income from 20p to 19p.
Additional reporting by Adam Samson in New York and Leo Lewis in Tokyo