The pound fell to an all-time low against the dollar on Monday, losing as much as 4.7% to $1.035 after British Chancellor Kwasi Kwarteng pledged to pursue more tax cuts.
The fall takes the pound to its lowest level since the decimalisation of the currency in 1971. The sudden movements of sterling came early in the Asian trading session, when low trading volumes on the pound-dollar pair can exacerbate volatility. At the start of European trading, the pound stood at $1.06 against the greenback.
The pound also fell 3.7% against the euro on Monday to €1.0787, hitting the lowest level since September 2020. The drop against the common currency underscored how the recent fall of the pound reflects not only the general strength of the dollar, but the concern over The UK economy.
Kwarteng on Friday unveiled £45 billion debt-financed package containing the biggest package of tax cuts in half a century. UK government bonds sold off strongly, with the 10-year gilt yield jumping 0.27 percentage points to 3.77%. The pound had also weakened to its lowest point since 1985 in response, below $1.09 – a level it broke on Monday.
The Westminster tax cuts come when the UK should already be spending £150billion to subsidize energy costs for consumers and businesses. A large part of these borrowings must be financed by gilts.
Unlike the major 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 Bank of England 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 rising interest rates by 0.5 percentage points on Thursday, following a third successive 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,” said currency analysts at Wall Street bank Goldman Sachs.
“With large unfunded fiscal spending without a monetary policy counterpart to offset the inflationary impulse, the currency is likely to weaken further.”
Traders and analysts in Asia said low trading volumes in the region likely exacerbated downward pressure on the pound.
“It’s unusual to see Asian markets leading the way on this, as this region is typically the price taker rather than the maker,” said Benjamin Shatil, currency strategist at JPMorgan. “I suspect we see the relatively weaker liquidity in these Asian markets playing a role here, with the fundamentals exacerbated by this liquidity dynamic.”
Additional reporting by Adam Samson in New York and Leo Lewis in Tokyo