–Speculation of Emergency Bank of England Action Lifts the Pound from $1.0350
–Market Disorder Follows Friday’s Tax-Cutting Fiscal Statement
By Laurie Laird
LONDON (MaceNews) – Sterling plunged to an all-time low against the dollar early on Monday, following a weekend pledge from the nation’s top finance minister to extend tax cuts beyond the £45billion announced in a fiscal statement on Friday.
The pound weakened to $1.0350, before recovering to near $1.0700 at midday in London, down 1.5% from Friday’s close.
The rout began on Friday, when Chancellor of the Exchequer Kwasi Kwarteng unveiled a massive reduction in taxes as part of the new government’s plan to raise the nation’s growth rate to 2.5%. Kwarteng reversed a planned corporate tax hike, abolished the top rate of income tax, removed the cap on bankers’ bonuses and reduced a national payroll tax, in what private economists called the biggest package of tax cuts since 1972.
Investors took fright at the breadth of the fiscal adjustment; sterling fell by more than 3% on Friday, from a level of $1.1157, while 10-year gilt yields rose by more than 30 basis points from 3.49% ahead of the announcement.
Kwarteng doubled down on his bet in a weekend television appearance, suggesting that further tax cuts are in the pipeline, without specifying where the axe could fall next.
Gilt yields rose further on Monday, with the 10-year rate hitting 4.09%, just 30 basis points below the equivalent Italian government instrument, despite the election of a far-right Italian government after Sunday’s election. UK two-year gilt yields rose by 49 basis points to 4.38%, while five-year yields gained 46 basis points to 4.50% at midday.
It was only widespread speculation that the Bank of England may be forced into action – most likely in the form of an emergency rate hike – that lifted sterling from its lows. “The pound has bounced back rather quickly as investors ramp up speculation that the Bank of England could intervene either by announcing an inter-meeting rate hike or by selling its foreign currency holdings,” said Matthew Ryan, head of market strategy at financial services firm Ebury.
Traders believe that foreign currency intervention – which must come under instructions from the Treasury – is unlikely, but few rule out some sort of communication from the Bank in the short term. The Bank’s Monetary Policy Committee lifted its benchmark rate by 50 basis points to 2.25% last Thursday, but markets are pricing in a rise of another 150 basis points by November, when the MPC next considers interest rates.
In minutes of last week’s meeting, which took place before Friday’s fiscal announcement, the MPC acknowledged that the forthcoming plan “was likely to contain news that was material for the economic outlook.” The Bank also conceded that the UK may have already fallen into recession, forecasting a 0.1% contraction in the current quarter, following a similar-sized decline in March-to-June period.
Bank of England economists – most conspicuously external member Catherine Mann – have expressed worries over the sterling weakness with inflation hovering at an annual rate of 9.9%.
New Prime Minister Liz Truss, who took office earlier this month, based her campaign on challenging economic orthodoxy, even suggesting a review of the Bank of England’s mandate. However, Kwarteng took pains to stress that he regards central bank independence as “sacrosanct” in his budget address on Friday.