The pound has fallen below $1.10 for the first time since 1985, as investors feared an increase in government borrowing to pay for Kwasi Kwarteng’s sweeping tax cuts.
Passing a punitive verdict on the chancellor’s ‘streaking growth’, traders plunged sterling into a broad sell-off on Friday in response to the massive surge in public borrowing needed to fund his plans.
Analysts at US investment bank JPMorgan said the market’s response showed “a wider loss of investor confidence in the government’s approach”, reflecting the damage to Britain’s position in global markets.
Citi analysts said the Chancellor’s tax refund, the largest since 1972, “invokes a crisis of confidence in sterling”.
Against the dollar, the pound fell two and a half cents to a new 37-year low of $1.0993 as fears over the future path for public finances also fueled a rise in government borrowing costs. The drop below the token $1.10 came after the chancellor announced £45 billion in tax cuts aimed at higher incomes.
The FTSE 100 fell more than 2% and traded below 7,000 for the first time since early March following the Russian invasion of Ukraine, while the cost of borrowing for the British government in international markets rose the most in a single day for more than a year. decade.
Yields on two-year UK government bonds – which are inversely proportional to the value of bonds and rise as they fall – rose a staggering 0.4 percentage point to almost 4%, reaching their highest level since the 2008 financial crisis.
The cost of borrowing on 10-year bonds rose by more than 0.2 percentage points to nearly 3.8%, continuing a dramatic rise since Liz Truss became prime minister earlier this month. In early September, benchmark UK government bond yields rose by almost one percentage point, significantly more than in comparable advanced economies.
“[It’s] It’s really hard to overstate the extent to which the Kwarteng budget has devastated the gold market,” said Toby Nangle, a former fund manager at Columbia Threadneedle. To illustrate the magnitude of the turmoil, he said five-year gold yields had risen the most in one day since 1993 — surpassing the Covid pandemic, the 2008 financial crisis and 9/11.
Investors warned that the UK’s Trussonnomics experiment comes at a challenging time with a rising US dollar, rising interest rates from global central banks and higher borrowing costs in advanced economies amid weaker economic growth and rising inflation.
However, they said Britain was singled out after the government spent years damaging its reputation for sound economic management, compounded by steps taken by the new prime minister.
Gabriele Foa, portfolio manager at Algebris Investments, said: “We are in a situation where the UK government has lost a lot of credibility over the past three to four years and has increased the patience of the market in many ways.
“[It’s about] Covid management, government instability, Brexit management. It’s just a big, shall we say, series of concerns. The UK was in first class, [but] it goes from the first to the second to the third. If you give signals that you are not reliable, you are shifting from competitions.”
It comes after the Treasury said it would fund the Chancellor’s tax cuts and the energy price guarantee for consumers and businesses with £72.4 billion in additional sales of UK government debt than planned for the current fiscal year.
Instead of the £161.7 billion planned by the Debt Management Office in April, the Treasury said it would now sell £234.1 billion worth of government bonds to international investors in 2022-23.
The change means investors are being approached to buy significantly more government debt than previously anticipated, and comes on top of the Bank of England preparing to sell £80bn of government bonds on its balance sheet thanks to its quantitative easing program.
Markets are betting that Kwarteng’s support schemes would force the Bank to raise interest rates above 5% — more than double the current rate of 2.25% — in May next year in the expectation that they will ease inflationary pressures. would increase significantly.
Vivek Paul, senior portfolio strategist at BlackRock, said: “The UK’s credibility is what markets respond to.
“Over time, we will know if there will be a fundamental change. The jury is out [but] the first reaction from the markets is not a resounding approval. Let’s put it this way.”
The measures come as the Bank responds to rising inflation by raising interest rates, despite warnings that the UK economy is already in recession.
Antoine Bouvet, a senior interest rate strategist, and Chris Turner, the global head of markets at Dutch bank ING, said conditions amounted to a “perfect storm” for the UK as global markets eschew sterling and gold.
“The price action in British gilts is going from bad to worse. A daunting list of challenges has emerged for investors in UK bonds, and the Treasury’s mini-budget has done little to bolster confidence.”