As financial markets reacted to the biggest tax cuts in 50 years, the pound fell to a new 37-year low against the dollar.
UK stocks fell after chancellor Kwasi Kwarteng announced a slew of tax cuts and economic measures as part of a massive overhaul of the country’s finances.
The pound dropped more than 3% against the US dollar, falling below $1.09.
The Sterling has recently fallen due to economic concerns and a stronger US dollar.
On Friday, the pound fell more than 1% against the euro, falling to €1.12.
Mr. Kwarteng refused to comment on the currency’s depreciation, saying he “doesn’t comment on market movements.”
Following the announcement, the cost of government borrowing skyrocketed, reaching near-record highs as investors calculated the new strategy.
According to Bloomberg data, analysts expect UK interest rates to reach 5.2% in August 2023, with expectations growing that the Bank of England will raise interest rates by one percentage point at its next meeting in November.
The market reaction was “worrying,” according to the Institute for Fiscal Studies (IFS), an economic think tank because the government’s new strategy relied on investors being willing to lend more to the UK.
“The plan appears to be to borrow large sums at increasingly expensive rates, put government debt on an unsustainable upward trajectory, and hope for better growth,” IFS director Paul Johnson said.
Mr. Johnson stated that the new strategy would inject demand into an economy with high inflation, risking further price increases. At the same time, the Bank of England was pulling in the opposite direction, with interest rates likely to rise even further in response to the £45 billion tax cut.
According to Deutsche Bank strategist George Saravelos, the Bank of England needs to make an emergency, unscheduled rate hike as soon as next week “to regain credibility with the market.”
He added that such a move would send a strong signal to the market that the bank is “willing to do ‘whatever it takes to bring inflation down quickly.”
Former US Treasury Secretary Larry Summers warned that the pound could fall below the dollar as a result of Mr. Kwarteng’s massive spending commitments.
“I’m sorry to say it, but I think the UK is behaving like an emerging market transitioning into a submerging market,” Mr. Summers told Bloomberg.
“I think Britain will be remembered for having pursued the worst macroeconomic policies of any major country in a long time, between Brexit, how far the Bank of England got behind the curve, and now these fiscal policies.”
According to Jane Foley, a currency strategist at Rabobank, the sterling sell-off indicates that investors are skeptical of the government’s plans.
“They are concerned that some of the recently announced tax cuts will not be fully funded. This will result in significant debt at a time when the Bank of England is selling some of its holdings of UK government debt, “She stated.
“This government, in my opinion, needs to provide a lot more assurance that it is fiscally responsible. This is not the message that has been conveyed this morning.”
The FTSE 100 index of major shares in the United Kingdom fell more than 2%, reaching its lowest level in more than two months, as investors worried that the stimulus plan would fail.
The plan also aided the sell-off in US markets, with the three major stock indexes falling more than 2%.
“Finally, the growth dice were rolled. However, it is too early to tell whether the gamble will pay off and boost confidence sufficiently to encourage businesses and individuals to spend and invest, thereby stimulating the UK economy, “Grant Thornton’s head of tax, Karen Campbell-Williams, agreed.
According to Thomas Pugh, an economist at RSM UK, the economy will likely grow by “roughly 1%” over the next year, reducing the risk of a long recession, but the longer-term outlook is less promising.
“Nothing in the budget makes us more optimistic about the economy’s long-term growth trend. Trend growth is currently likely to be half of the 2.5% target set by the Chancellor, “He stated.