GBP/USD falls sharply after government’s small budget

LONDON – Sterling hit a record low against the dollar on Monday after the new government rolled out sweeping tax cuts to boost economic growth, adding to fears of a global recession.

Sterling’s fall came as Britain grappled with a cost of living crisis and a surge in public debt caused by deteriorating investor confidence. It also raised the prospect that the Bank of England could intervene to support the pound.

The slump partly reflected a stronger dollar, which was buoyed by higher interest rates. But it also fell against many other currencies, indicating specific concerns about the UK economy.

Who is the new British Prime Minister Liz Truss?

Sterling hit a record low of $1.03 in Asian trading on Monday morning, before paring some of its losses and settling around $1.08 – still well below levels before the government’s “mini budget” on Friday morning.

Economies slumped as global markets faltered and recession fears intensified in many regions. In the U.S., the Federal Reserve last week raised interest rates to keep a lid on high inflation. It was the fifth rate hike this year and the third in a row by three-quarters of a percentage point. This shocked Wall Street, and by Friday, the Dow Jones Industrial Average had closed below 30.0000, falling to its lowest point since 2020.

“We have to get rid of inflation,” Federal Reserve Chairman Jerome H. Powell said last week. “I wish there was a painless way to do this. No.”

Major U.S. stock indexes fell early Monday afternoon, with the Dow down about 275 points, or 0.9 percent, and the S&P 500 down 0.9 percent. The tech-heavy Nasdaq fell 0.3%.

The Bank of England said on Monday that “it is closely monitoring developments in financial markets in light of the significant repricing of financial assets.”

The central bank said in a statement that its Monetary Policy Committee will conduct a “comprehensive assessment” of the impact of government action and the fall in sterling at its next meeting, scheduled for November.

“The MPC will, in accordance with its terms of reference, not hesitate to change interest rates if necessary to bring inflation back to the 2 percent target sustainably over the medium term,” it said.

Sterling fell about two months after the euro reached parity with the dollar for the first time in nearly two decades. The Ukrainian war has disrupted food supplies, causing global energy costs to soar, especially in Europe. This, combined with the Fed’s rate hikes, makes the dollar a relatively safe bet for investors.

Mike Riddell, senior fixed income portfolio manager at Allianz Global Investors, said the pound’s decline “is not necessarily a sign of a recession in Europe.” Instead, investors began to doubt Britain’s ability to fight inflation.

“It’s scary that the global economy has yet to feel the effects of all the rate hikes we’ve seen around the world over the past few months, as it takes about a year for changes in monetary policy to have an impact on the economy,” he said in an email. said in.

Of course, currency weakness does not necessarily reflect economic weakness. This could be beneficial in many cases, such as making UK exports cheaper for US consumers – so a weaker pound would boost overseas sales by export-oriented companies. But that means anything denominated in dollars, like energy costs, will skyrocket for consumers.

That’s good news for American tourists in the UK who suddenly find their dollars go further. That’s not good news for many British households already facing soaring energy bills and inflation of up to 10%. They will find that the cost of imported goods and services will go up, including everything from motor fuel to food on a plate – by 2020 the UK imports 46% of food consumed.

On Friday, the new chancellor, or finance minister, Kwasi Kwarteng, announced a package of tax cuts worth 45 billion pounds ($48 billion), the biggest overhaul of its tax system in 50 years. The top income tax rate of 45% has been slashed, the cap on banker bonuses will be removed and the home purchase tax will also be slashed – moves that will mostly help wealthier citizens who will hopefully spend more.

The size of the tax cuts has surprised many economic observers, despite promises by new Prime Minister Liz Truss during the campaign.

“In the current economic climate, this is a huge gamble,” wrote Thomas Pope, an economist at the Institute of Government. It’s a major shift from the policies of Truss’ predecessor, Boris Johnson, who announced tax increases last year to help pay for the fight against the pandemic.

The new UK government hopes that by cutting taxes and regulation, it will be able to generate growth, fund public services and eventually pay down debt.

John Hardy, head of FX strategy at Saxo Bank, said the pound was slipping as investors were not reassured by the government’s calculations.

“It’s a numbers game and their numbers don’t add up,” he said.

Investors are watching where inflation is headed and the UK’s balance sheet.

“They said, ‘I don’t want to own British newspapers because they’re not playing responsibly,'” Hardy said.

Truss, just three weeks into his new job, defends the wealth of the tax cuts.

In a recent interview, CNN’s Jack Tapper told Truss that the U.K. opposition was describing her plan as “recklessly increasing the deficit” and that President Biden was “essentially saying your method doesn’t work”.

last week, Biden tweet: “I’m sick of trickle-down economics. It never worked.” He was referring to supply-side economics, famous by President Ronald Reagan, which is very similar to Truss’s approach.

In the interview, Truss responded: “The UK has one of the lowest levels of debt in the G7. But we have one of the highest levels of taxation. Right now, we have the highest tax rate in 70 years. As Prime Minister , what I’m determined to do, and what the Prime Minister is determined to do, is to make sure we incentivize businesses to invest. We’re also helping ordinary people pay their taxes.”

Truss continued: “That’s why I don’t think it’s appropriate to raise National Insurance and increase corporate tax because it will make it harder for us to attract the investment we need in the UK. It will also be harder to create these new jobs. “. “

Rachel Lerman in Washington contributed to this report.

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