The British pound crashed below $1.10 mid-afternoon, hitting a fresh 37-year low against the greenback.
Finance Minister Kwasi Kwarteng said the government would cut personal income tax and roll back plans to raise corporate taxes next spring, calling for a “new approach for a new era, focused on the growth”. At the same time, he pledged to move forward with plans to subsidize the energy bills of millions of households and businesses.
But investors are unconvinced the unconventional approach will actually help the economy, which the Bank of England this week warned was already likely in recession. A number of them called it a huge gamble.
“It is extremely unusual for a currency in a developed market to weaken at the same time as yields rise sharply. But that is exactly what has happened since the [Kwarteng’s] announcement,” Deutsche Bank strategist George Saravelos said in a note to clients on Friday.
Towards parity with the dollar?
Lower taxes, while politically popular, could also boost demand and drive up prices, making it even more difficult for the central bank to keep inflation under control.
Analysts have warned that the pound and UK bonds are likely to fall further.
Some have even speculated that the currency could fall to parity with the dollar for the first time in its history. (Its previous all-time low was just above $1.05 in 1985). The greenback’s staggering rally as the Federal Reserve takes aggressive action to contain inflation adds to the downside pressure.
“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 steer clear of the pound,” said Antoine Bouvet and Chris Turner. at ING in a research note. “We think the market may be underpricing the chances of parity.”