GBP/USD falls sharply after government’s small budget

LONDON — Sterling slumped to a record low against the dollar on Monday, fueling fears of a global recession and reflecting a highly negative view of a massive tax cut package financed by the new British government through heavy borrowing.

Sterling fell to as low as $1.03 in Asian trade early on Monday before recovering some losses and stabilizing around $1.08 – still well below levels on Friday morning before details of the government’s tax cuts to boost economic growth were announced.

The slide could be good news for the many American tourists who visit here and suddenly find their dollars go further. The U.S. dollar is in a strong position after a series of rate hikes by the Federal Reserve.

However, it is worrisome for many British households, who already face soaring energy bills and inflation of up to 10%. They could soon face higher costs for imported goods and services, including everything from motor fuel to food on their plates.

Last week, Britain was able to put on a show for the world, hosting an elaborate state funeral for Queen Elizabeth II. But now financial and economic issues are again in focus. Prime Minister Liz Truss’ honeymoon period – just three weeks into office – is clearly over.

Who is the new British Prime Minister Liz Truss?

Despite Trus’s campaign promises to cut taxes, the size of the tax cuts surprised many economic observers.

“In the current economic climate, this is a huge gamble,” wrote Thomas Pope, an economist at the Institute of Government.

On Friday, the new chancellor, or finance minister, Kwasi Kwarteng, announced a package of cuts worth 45 billion pounds ($48 billion), the biggest overhaul of Britain’s tax system in 50 years.

It is also a major shift in policy from Truss’ predecessor, Conservative Party member Boris Johnson, who last year announced tax hikes to help cover the cost of the pandemic.

Under Truss, the government has cut the top income tax rate by 45% for those earning more than £150,000 ($160,000) a year and removed caps on bankers’ bonuses – moves that will mostly help wealthier citizens , hope they will increase spending.

In a broader measure, the government will cap energy bills from October – costing £60bn over six months.

The pound slump raised the prospect that the Bank of England could intervene to support the currency. But the central bank rejected an emergency rate hike on Monday.

The Bank of England said it is “monitoring developments in financial markets closely in light of the significant repricing of financial assets.”

The central bank said in a statement that its Monetary Policy Committee will conduct a “comprehensive assessment” of the impact of government action and the fall in sterling at its next meeting, scheduled for November.

“The MPC will, in accordance with its terms of reference, not hesitate to change interest rates if necessary to bring inflation back to the 2 percent target sustainably over the medium term,” it said.

Economies slumped as global markets faltered and recession fears intensified in many regions. In the U.S., the Federal Reserve last week raised interest rates to keep a lid on high inflation. It was the fifth rate hike this year and the third in a row by three-quarters of a percentage point. This shocked Wall Street, and by Friday, the Dow Jones Industrial Average had closed below 30.0000, falling to its lowest point since 2020.

“We have to get rid of inflation,” Federal Reserve Chairman Jerome H. Powell said last week. “I wish there was a painless way to do this. No.”

Major U.S. stock indexes fell early Monday afternoon, with the Dow down about 275 points, or 0.9 percent, and the S&P 500 down 0.9 percent. The tech-heavy Nasdaq fell 0.3%.

Sterling fell about two months after the euro reached parity with the dollar for the first time in nearly two decades. The Ukrainian war has disrupted food supplies, causing global energy costs to soar, especially in Europe. This, combined with the Fed’s rate hikes, makes the dollar a relatively safe bet for investors.

Mike Riddell, senior fixed income portfolio manager at Allianz Global Investors, said the pound’s decline “is not necessarily a sign of a recession in Europe.” Instead, investors began to doubt Britain’s ability to fight inflation.

“It’s scary that the global economy has yet to feel the effects of all the rate hikes we’ve seen around the world over the past few months, as it takes about a year for changes in monetary policy to have an impact on the economy,” he said in an email. said in.

Of course, currency weakness does not necessarily reflect economic weakness. This could be beneficial in many cases, such as making UK exports cheaper for US consumers – so a weaker pound would boost overseas sales by export-oriented companies. But that means anything denominated in dollars, like energy costs, will skyrocket for consumers.

The new UK government hopes that by cutting taxes and regulation, it will be able to generate growth, fund public services and eventually pay down debt.

John Hardy, head of FX strategy at Saxo Bank, said the pound was slipping as investors were not reassured by the government’s calculations.

“It’s a numbers game and their numbers don’t add up,” he said.

Investors are watching where inflation is headed and the UK’s balance sheet.

“They said, ‘I don’t want to own British newspapers because they’re not playing responsibly,'” Hardy said.

Truss, just three weeks into his new job, defends the wealth of the tax cuts.

In a recent interview, CNN’s Jack Tapper told Truss that the U.K. opposition was describing her plan as “recklessly increasing the deficit” and that President Biden was “essentially saying your method doesn’t work”.

last week, Biden tweet: “I’m sick of trickle-down economics. It never worked.” He was referring to supply-side economics, famous by President Ronald Reagan, which is very similar to Truss’s approach.

In the interview, Truss responded: “The UK has one of the lowest levels of debt in the G7. But we have one of the highest levels of taxation. Right now, we have the highest tax rate in 70 years. As Prime Minister , what I’m determined to do, and what the Prime Minister is determined to do, is to make sure we incentivize businesses to invest. We’re also helping ordinary people pay their taxes.”

Truss continued: “That’s why I don’t think it’s appropriate to raise National Insurance and increase corporate tax because it will make it harder for us to attract the investment we need in the UK. It will also be harder to create these new jobs. “. “

Rachel Lerman in Washington contributed to this report.

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