Britain’s currency is in trouble, and things could get much worse for sterling, experts warn.
The British pound crashed to a record low below $1.05 in early trading on Monday, before recovering some of its losses to trade around $1.07.
Britain’s struggling currency, which had already fallen to a 37-year low earlier this month, continued its slide on Friday after newly appointed Finance Minister Kwasi Kwarteng unveiled the biggest package of tax cuts of the country in half a century.
The planned review includes cuts in the amount of income tax paid by Britain’s richest, a cancellation of the planned rise in corporation tax and a reduction in stamp duty, a tax paid by Britons when they buy a house.
The tax cuts are expected to cost around 45 billion pounds ($48 billion) in 2026, on top of an estimated $60 billion the government will spend on a bailout of national energy bills over the winter.
The pound’s slide deepened further after Kwarteng doubled down on tax cuts, telling the BBC on Sunday there was “more to come”.
Spooked by the potential impact of tax cuts on the already fragile UK economy, investors sent sterling to a new low of $1.033 to the greenback.
Asked by a reporter about the turmoil in the markets on Monday morning, Kwarteng declined to comment.
“An underground market”
As investors continue to digest the new UK government’s fiscal policies, economic and policy experts have been warning that the historically strong pound could have much more to fall.
In an interview with Bloomberg on Friday, former US Treasury Secretary Larry Summers criticized the policies of the government of new Prime Minister Liz Truss.
“I’m very sorry to say it, but I think the UK is behaving a bit like an emerging market, becoming a submerged market,” he said. “There is nothing in the pattern of market response in the UK that suggests anything other than fear rather than confidence in the policy approaches being taken.”
Summers, who served as Treasury secretary in the Clinton administration and was director of the National Economic Council under President Barack Obama, warned of dire consequences for Britain if its lawmakers continued their austerity policies of taxes
“I wouldn’t be surprised to see the pound go below a dollar if the current policy trajectory continues,” he warned.
“This is simply not a time for the kind of naively delusional supply-side economics that is going on in Britain… I think Britain will be remembered for having followed the worst policies macroeconomics of any major country in a long time.”
Summers is not alone in his criticism of the UK’s new tax policy.
Kenneth Clarke, who served as UK finance minister under former prime minister John Major, said in an interview with the BBC on Sunday that the “general premise” of the tax cuts was “wrong” and could lead to economic disaster.
“I’m afraid it’s the kind of thing that tends to be tried in Latin American countries without success,” he said.
Beyond falling
As bad as the fall has been, several currency analysts say the pound still has more to fall.
In a research note published by ING on Friday, Antoine Bouvet, senior rates strategist at ING, and Chris Turner, global head of markets at the Dutch bank, predicted that investors will continue to trade sterling given “fiscal concerns” .
“Unless something can be done to address these fiscal concerns, or the economy shows surprisingly strong growth data, it looks like investors will continue to avoid sterling,” they warned, noting that the chances of the currency reach parity with the US dollar they had. more than doubled in just months.
“Forex options now rate the chances of GBP/USD hitting 1.00 by the end of the year at 17%,” they said. “This is up from 6% at the end of June. Given our bias for the dollar’s recovery to also be overplayed, we believe the market may be underestimating the chances of parity.”
Meanwhile, Jane Foley, senior currency strategist at Rabobank, warned in a note on Monday that UK fiscal policy was now in direct conflict with the Bank of England’s monetary targets.
“Accordingly, the expectation that the Bank would have to tighten even more aggressively had grown even before the pound hit this morning’s woeful levels, with the market already eyeing the possibility of even bigger incremental hikes “, he said. “It is clear that the BoE’s ‘moderate’ rate hikes this year have done very little to support the pound in the face of a rising US dollar. This has fueled speculation that the [Bank of England] It may be forced to consider large rate hikes in emerging markets to avoid further losses in the value of the GBP.”
Foley noted that if that were to happen, it could put aggressive pressure on demand and undo the impact of Kwarteng’s tax cuts, “leaving only a legacy of higher debt.”
Market intervention?
With the pound falling, some market watchers have speculated that British policy makers can step in and intervene in the markets to save the value of sterling.
But the UK may find it more difficult than other major economies to take such measures.
The data show that the UK’s foreign currency holdings are a fraction of those of some of its peers, Bloomberg reported on Monday. For example, Japan, which intervened to strengthen the weakening yen for the first time since the legal week of the 1990s, had almost $1.2 trillion in foreign exchange reserves at the end of August, while the United Kingdom had 108 billion dollars.
However, the interventions may not be enough to strengthen sterling if the UK stays on its current policy path, some have warned.
Adam Posen, president of the Peterson Institute for International Economics, he said on Twitter over the weekend, UK government currency intervention would be “unnecessary and probably self-harming”.
“I hope they don’t,” he said. “But given that the only real alternative is the fiscal U-turn, I hope so [the Prime Minister and Finance Minister] to try it.”
Meanwhile, economist Jens Nodvig, who founded New York-based Exante Data,noted in a tweet that currency intervention is a costly maneuver that “would only be a solution for a few minutes, adding to long-term difficulties” for Britain.
“The bottom line is that the UK faces a major economic challenge and increasingly a financial markets challenge/crisis,” he said. “There is no easy fix and currency intervention is very likely to fail.”
