The pound fell below $1.09 on Friday for the first time since 1985 as investors took fright at the prospect of a surge in government borrowing to pay for the sweeping tax cuts in Kwasi Kwarteng’s mini-budget.
Issuing a punishing verdict on the chancellor’s “dash for growth”, traders sent sterling tumbling on Friday in a broad-based sell-off in response to the huge rise in public borrowing required to finance his plans.
The cost of UK government borrowing rose by the most in a single day for at least a decade, while the currency meltdown fuelled speculation the Bank of England would be forced to launch an emergency rate rise to mend the UK’s battered credibility with global investors.
Analysts at Deutsche Bank said the sell-off showed investors were “no longer willing to fund the UK’s external deficit position at the current configuration”, while adding: “The policy response required to what is going on is clear: a large, inter-meeting rate hike from the Bank of England as soon as next week to regain credibility with the market.”
The US investment bank JPMorgan said it exposed “a broader loss of investor confidence in the government’s approach,” while Citi said the chancellor’s tax giveaway, the biggest since 1972 , risked “a confidence crisis in sterling”.
The pound fell by three and a half cents against the dollar to a fresh 37-year low, trading below $1.09, as fears over the future path for the public finances also triggered a surge in government borrowing costs. The fall came after the chancellor announced £45bn of tax cuts directed at higher earners.
“I worked on some 60 fiscal events over 31 years. I can’t remember any generating as strong a market reaction as today’s,” said Nick Macpherson, the former permanent secretary to the Treasury under three chancellors.
When asked about the fall in sterling on a visit to Kent after the mini-budget, Kwarteng said: “I don’t comment on market movements.”
On a day of heavy selling pressure across global financial markets, the FTSE 100 finished the day down 2%, after recovering ground after falling below 7,000 earlier in the day for the first time since early March, after Russia’s invasion of Ukraine.
Two-year UK government bond yields – which are inversely related to the value of bonds and rise as they fall – jumped by as much as 0.4 percentage points to come close to 4%, reaching the highest level since the 2008 financial crisis.
The yield on 10-year bonds rose more than 0.2 percentage points, close to 3.8%, continuing a dramatic climb under way since Liz Truss took over as prime minister earlier this month. At the start of September, yields on benchmark UK sovereign debt have risen by almost one percentage point, significantly more than for comparable advanced economies.
Finance industry leaders said UK assets were tumbling by a much bigger extent than comparable leading economies.
Larry Summers, the former US Treasury chief, said he would not be surprised if the pound fell below parity with the dollar if Truss’s government continues on its current path. “The UK is behaving like an emerging market turning itself into a submerging market,” he told Bloomberg TV.
“[It’s] really hard to overstate the degree to which the Kwarteng budget has just wrecked the gilt market,” said Toby Nangle, a former fund manager at Columbia Threadneedle. Illustrating the scale of the turmoil, he said five-year gilt yields had moved by the most in a single day since 1993 – surpassing the Covid pandemic, the 2008 financial crisis, and 9/11.
Britain’s experiment with Trussonomics comes at a challenging moment, as the US dollar strengthens on international markets, major central banks raise interest rates, and advanced economies around the world face an increase in borrowing costs amid lower growth and soaring inflation.
However, investors said Britain was being singled out after years of the government damaging its reputation for sound economic management, compounded by the steps being taken by the new prime minister.
Gabriele Foa, a portfolio manager at Algebris Investments, said the UK had lost a “lot of credibility” and had “pushed the market’s patience” through a series of economic missteps.
“[It’s about] Covid management, government instability, the management of Brexit. It is just a big, let’s say, series of concerns. The UK was in the first league, [but] it’s moving from first, to second to third. If you give some signs that you’re not reliable you move leagues.”
In order to finance the chancellor’s tax cuts and energy price guarantee the Treasury said it would need to issue £72.4bn in additional UK government bonds to investors in the current financial year, taking the total to £234.1bn in 2022-23.
It comes at a time when the Bank of England is also selling £80bn of gilts held on its balance sheet built up under its quantitative easing programme, adding to the large volume of government bonds being sold to investors.
Markets bet the Bank would be forced to ramp interest rates above 5% by May next year – more than double the current rate of 2.25% – on the expectation Kwarteng’s tax cuts would add significantly to inflationary pressures.
Vivek Paul, UK chief investment strategist at the BlackRock Investment Institute, said: “The credibility of the UK is what markets are reacting to.
“Over time we will know if there will be a fundamental change. The jury is out, [but] the initial reaction from markets is not a ringing endorsement. Let’s put it that way.”