Pound sinks as investors question huge tax cuts

Share on facebook
Share on linkedin
Share on twitter


Image Source: USA Herald

As financial markets reacted to the most significant tax cuts in 50 years, the pound dropped to a new 37-year low versus the dollar.

UK stocks also fell after chancellor Kwasi Kwarteng announced a slew of economic and tax reforms as part of a major restructuring of the nation’s finances.

The pound dropped below $1.09 against the dollar, falling more than 3%.

Recent declines in the pound have been attributed to both economic concerns and a stronger US currency.

On Friday, the pound decreased by more than 1% in value relative to the euro, falling to €1.12.

As he “doesn’t comment on market movements,” Mr. Kwarteng declined to address the declining value of the currency.

Following the announcement, the cost of government borrowing skyrocketed and increased by almost record levels as investors weighed the pros and cons of the new approach.

Analysts predict that UK interest rates will reach 5.2% in August 2023, according to data from Bloomberg. At the Bank of England’s meeting in November, there may be a one percentage point increase in interest rates.

An economic think tank called the Institute for Fiscal Studies (IFS) described the market response as “worrying” because the government’s new approach depends on investors being more ready to lend money to the UK.

IFS director Paul Johnson said, “seems to be to borrow significant amounts at ever-expensive rates, put government debt on an unsustainable growing trend, and hope that we achieve higher growth.”

According to Mr. Johnson, the new approach would risk more price increases by injecting demand into an economy with high inflation. In opposition to this, the Bank of England was pushing interest rates higher and was anticipated to do so in response to the £45 billion tax cut.

According to Deutsche Bank strategist George Saravelos, the Bank of England needs to issue an urgent, unexpected rate move as soon as next week “to reestablish trust with the market.”

That action, according to him, would also strongly suggest that the bank is “ready to do ‘whatever it takes to fast drive inflation down.”

Larry Summers, a former US Treasury secretary, issued a warning that the massive spending pledges stated by Mr. Kwarteng could cause the pound to drop below the dollar.

Concerns that the strategy to spur the economy might not be successful were reflected in a more than 2% decline in the leading stock index FTSE 100 in the UK, which plummeted to its lowest level in more than two months.

The three major stock indices in the US markets sank more than 2% as a result of the plan.

Experts speak on the British Pounds

According to Thomas Pugh, an economist at RSM UK, the economy would likely grow by “approximately 1%” over the course of the next year, lessening the likelihood of a lengthier recession, but the longer-term picture is less encouraging.

Additionally, the similarly enormous borrowing has sent markets into a tailspin even if it should at first ease part of the recession we are most certainly already in.

With some of the worst one-day increases in borrowing costs since the 1990s, it was one of the worst days for UK government bonds in decades.

This has implications for the government as well as setting the benchmark for long-term borrowing rates for businesses and households.

Market ambiguity has been exacerbated by a lack of data, visibility, and demonstrable commitment to limiting government borrowing.

The government did not release the figures underlying the £72 billion additional borrowing it had to announce to the markets this year. However, interest rates on British debt reached 4%, up from 3.1% earlier this week and 1.8% at the start of Rishi Sunak’s leadership campaign.

Read Also: Pound hits new 37-year low as retail sales slide 

The Treasury’s response to all of this is a table of estimates that illustrates the amount of tax income that would be generated if its policies successfully raised economic growth over the long term.

Although every chancellor and politician aspires to that table, the markets have not been persuaded. So the actual tax has been replaced with a presumption of more tax income.

During her candidacy for prime minister, the prime minister attacked bean counters. Unfortunately, the ledger is only partially displayed in today’s plan. Focusing on financial credibility is typical for a chancellor making their debut. However, that wasn’t the main concern here.