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International confidence in the UK has been badly hammered by the mini-budget, and the Truss government’s tax-cutting policies, and the pound is paying the price.
Sterling had plunged to a record low against the US dollar in Asia-Pacific trading, extending the losses suffered on Friday, and moving closer to parity.
Investors have been rocked by the bonanza of tax cuts announced in Kwasi Kwarteng’s mini-budget – with the UK chancellor pledging over the weekend to pursue more tax cuts.
The pound plunged nearly 5% at one point to around $1.0327, Reuters data shows, a record low since at least decimalisation in 1971, as belief in the UK’s economic management and assets evaporated.
Even after stumbling back to $1.05 as City traders reach their desks this morning, the currency was down 7% in two sessions.
It could be a volatile day, with fears over a global downturn also hitting the markets.
Naeem Aslam, chief market analyst at Avatrade, has a scathing assessment of the situation:
Sterling is getting absolutely pounded today in this week’s trading, and traders have started things exactly where they left off on Friday.
Sterling looks like an emerging market currency, especially when you look at the price of the British Pound a few months ago and compare it to where it is now.
Marc Chandler, chief market strategist at Bannockburn Global Forex, called the currency’s record plunge “incredible”. He believes there is bound to be speculation of an emergency Bank of England meeting and rate hike.
The pound has now slumped by almost 10% so far this month, hit by anxiety over a looming recession, and the surge in borrowing needed to fund Kwarteng’s £45bn giveaway.
Yesterday, Kwarteng told BBC One’s Sunday with Laura Kuenssberg tha Liz Truss plans to radically reshape the UK economy with even more tax cuts and fewer regulations/
“There’s more to come,” Kwasi Kwarteng said, declining to set a limit on how much public debt could be incurred in the process.
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”.
Weston told clients:
“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.
The City is now looking to see whether the Bank of England takes steps to calm the markets.
On Friday afternoon, Deutsche Bank analyst George Saravelos said the BoE should hold a big inter-meeting interest rate hike as early as this week to calm markets and restore credibility….
Here’s the full story:
9am BST: German Ifo Business Climate index
1.30pm BST: Chicago Fed National Activity Index on the US economy
2pm BST: ECB president Christine Lagarde appears at the Economic and Monetary Affairs committee of the European Parliament in Brussels
It is looking more and more likely sterling will fall to parity against the dollar this year based on option market pricing, Bloomberg has calculated.
Here’s the details:
Sterling-dollar implied volatility suggests there is a 60% probability spot will hit 1.00 before the end of this year — based on spot trading at $1.0552 — compared to 32% on Friday.
Markets are also expecting extreme turbulence, with sterling-dollar’s three month implied volatility surging 4.31 percentage points to 20.05% Monday. That’s fast approaching the high of 20.62% reached during the 2020 pandemic meltdown.
The jump in UK gilt yields is pushing up the cost of borrowing for a decade to a 12-year high – exactly when Britain’s government is planning an awful lot more borrowing.
It’s going to be expensive….
Investors seem inclined to regard the UK Conservative Party as a doomsday cult, according to Paul Donovan, chief economist of UBS Global Wealth Management.
In his morning comment, Donovan gives an absolutely blistering verdict on the government’s plans:
The global signals from the UK’s mini-budget matter. Modern monetary theory has been taken into a corner by the bond markets and beaten up. Advanced economy bond yields are not supposed to soar the way UK gilt yields rose.
This also reminds investors that modern politics produces parties that are more extreme than either the voter or the investor consensus. Investors seem inclined to regard the UK Conservative Party as a doomsday cult.
Tax cuts are unlikely to give the UK a meaningful medium-term boost (the supply constraints in the UK economy are more about health and education). A short-term “sugar high” is likely but may be limited. A high-income earner’s rational response would be to increase savings in anticipation of future tax increases.
Chancellor Kwasi Kwarteng is wrong to be relaxed about the market reaction to the mini-budget, accordining to Mohamed El-Erian, an advisor to financial service giant Allianz.
El-Erian, who’s also President of Queens’ College, Cambridge, says Kwarteng should be paying really close attention, otherwise “what’s happening in markets can snowball and undermine what he’s trying to do”.
El-Erian told the Today Programme that the moves in yields and the pound will translate into “even stronger stagflationary winds”, and that goes against Kwarteng’s push for growth.
El-Erian added that the Bank of England should hike interest rates by one percentage point if British finance minister Kwasi Kwarteng does not ‘recalibrate’ the mini-budget, removing the extra tax cuts that were introduced, which surprised the markets.
If the chancellor leaves his plans alone, the Bank of England should raise interest rates at an emergency meeting. But that also goes against Kwarteng’s plans.
Driving the car with the chancellor’s foot on the accelerator, and the Bank governor’s foot on the brake, is not a good way to drive the UK economy, El-Erian warns.
But even so, El-Erian says he would raise rates by a percentage points, if the chancellor didn’t change course.
“If I were the governor and the chancellor is not modifying his plan, I would increase interest rates and not by a little, by 100 basis points, by one full percentage point to try and stabilise the situation,”
He’s also written about his concerns for the Guardian today, here:
Economist Shaun Richards suggest the Bank of England should stop its plan to start selling some of its stocks of UK gilts.
The BoE has decided to start unwinding its quantitative easing (QE) programme by selling £80bn gilts over the next few months. That, though, will add to the selling pressure in the bond market.
Putting quantitative tightening (QT) on hold could calm the markets…
…. and they’re certainly far from calm now, as UK gilts are being routed:
Shadow chancellor Rachel Reeves has accused Kwasi Kwarteng of having “fanned the flames” of the falling pound by hinting at further “unfunded” tax cuts.
Reeves told BBC Radio 4’s Today programme:
“It is incredibly concerning.
“I think many people had hoped over the weekend things would calm down but I do think the Chancellor sort of fanned the flames on Sunday in suggesting there may be more stimulus, more unfunded tax cuts, which has resulted overnight in the pound falling to an all-time low against the dollar.”
UK bonds are continuing to slump – pushing yields even higher.
The two-year gilt yield (which measures short-term borrowing costs) has hit 4.5% – double its level in mid-August.
Here’s Reuters’ take:
British government bond prices collapsed on Monday when trading started, after sterling hit a record low against the U.S. dollar overnight, pushing yields to their highest in more than a decade.
Five-year gilt yields jumped more than 40 basis points to 4.503%, their highest since October 2008, while two-year yields rose more than 50 basis points amount to their highest since September 2008 at 4.533%.
UK government bonds are selling off sharply in early trading – again, adding to the losses on Friday immediately after the mini-budget.
The yield, or interest rate, on UK two-year, five-year and ten-year gilts have all surged dramatically.
Yields (which rise when prices fall) measure the interest rate on the bond – so this shows that the UK’s cost of borrowing has jumped, just as it needs to borrow an extra £72bn this year to cover Kwasi Kwarteng’s plans.
The two-year gilt yield rose by 37 basis points (0.37 percentage points) at the start of trading, to 4.365%, the highest level since September 2008 – at the start of the financial crisis.
The five-year gilt yield has jumped 32 basis points to 4.38%, a level not seen since October 2008 (the month Lehman Brothers collapsed).
And the benchmark 10-year gilt yield rose to 4.08% at the open, the highest since April 2010 – a rise of 25 basis points today.
The FTSE 100 index of blue-chip companies listed in London has opened 0.33% higher, after recovering a little of Friday’s 2% slide.
The weak pound will benefit major exporters, making their goods and services more competitive overseas. Consumer goods maker Reckitt Benckiser (+2.8%), drinks group Diageo (+2%) and pharmaceuticals firm GSK (+1.7%) are among the risers.
But, the domestically-focused FTSE 250 index (a better gauge of the UK economy) has dropped by 0.75%, to its lowest since November 2020.
House-builders are leading the fallers in London, on fears of higher interest rates that will hit the property market.
The pound has clawed back some of its earlier losses, after its alarming crash in Asia-Pacific markets overnight.
Sterling is still in the red against the dollar, down 1.3% today at $1.071, still one and a half cents below Friday’s close.
On Friday, the pound shed four cents as investors were spooked by the surge in borrowing needed to fund Kwarteng’s plans. And back at the start of September, the pound was worth around $1.15.