The pound plunged 4.7% to a record low after Kwasi Kwarteng vowed to press on with more tax cuts, even as markets delivered a damning verdict on the new Chancellor of the Exchequer’s fiscal policies.
The bulk of the currency’s slide on Monday took place in a frantic 20-minute selloff, evoking cries of a flash crash by traders. The beleaguered currency fell to as low as US$1.0350, as investors punished the Chancellor for his unapologetic dash for growth. It was at US$1.0558 at noon in Tokyo.
The decline followed the release on Friday of the government’s “Growth Plan,” a budget in all but name and the biggest tax giveaway in half a century. If the rout continues and widens into broader markets, there’s a risk Prime Minister Liz Truss’s days-old administration may be pushed into a crisis that could force a rapid policy response.
“The pound’s crash is showing markets have a lack of confidence in the UK and that its financial strength is under siege,” said Jessica Amir, a strategist at Saxo Capital Markets in Sydney. “The pound is a whisker away from parity and the situation is going to only worsen from here.”
Hedge funds had ramped up bullish bets on sterling just days before, with leveraged investors adding 13,488 net long contracts during the week to Sept. 20, the biggest increase since March, data from the Commodity Futures Trading Commission show.
The size of the pound’s intra-day decline on Monday was the biggest since March 2020. Option markets show the odds of the currency falling to parity with the dollar has now risen to 54% this year.
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Truss will face a rebellion from Tory backbenchers against her tax cuts if the pound falls to parity with the dollar, the Telegraph reported Saturday. Meanwhile, some in the markets are already calling for emergency BOE action to stem the tide, an unprecedented action in modern times that would risk adding to the sense of panic.
“The scale of the move today means the BOE will be forced into action, at the very least to try and jawbone some stability,” said John Bromhead, currency strategist at Australia & New Zealand Banking Group in Sydney. An “inter-meeting hike is incoming,” with traders already pricing in a 100 basis-point increase by the central bank in November, he said.
Kwarteng scrapped the top level of income tax and cut the basic rate by a percentage point, while also reversing an increase in the National Insurance payroll tax brought in earlier this year. On Sunday, he appeared unperturbed by the ferocious response that sent UK assets tumbling, telling BBC television that he wouldn’t comment on market movements, but when it comes to tax cuts, “there’s more to come.”
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“We’ve only been here 19 days,” the chancellor said. “I want to see, over the next year, people retain more of their income, because I believe that it’s the British people that are going to drive this economy.”
Backlash
Yields on UK gilts jumped by a record amount for some maturities on Friday. If maintained, the increase will dramatically inflate the cost of the extra £400 billion (US$422 billion) of borrowing the Resolution Foundation estimate is needed over the next five years to fund the growth plan, adding to an interest bill already bulging thanks to sky-high inflation and Bank of England rate increases.
The opposition Labour Party -- already enjoying a comfortable lead in the polls -- is seeking to capitalize on the policy gulf that’s opened up with the Tories at its annual conference, which began in Liverpool on Sunday. Leader Keir Starmer told the BBC he’d reverse Kwarteng’s most eye-catching measure -- the scrapping of the top 45% rate of income tax levied on earnings over £150,000.
Shorting the pound “is not only market’s favorite trade for a stagflation proxy but the pound is also facing a confidence issue,” said Christopher Wong, a currency strategist at Oversea-Chinese Banking Corp. in Singapore.
