City braces for more volatility after mini-budget drop | Sterling

Investors in the city are bracing for more volatility after a windfall of tax cuts and spending measures in the Kwasi Kwarteng mini budget threatened to undermine their confidence in the UK.

The odds of the pound hitting parity with the US dollar, for the first time ever, jumped after the pound fell below $1.09 on Friday, as traders grew increasingly worried about the UK budget and current account deficits.

Chris Weston, head of research at brokerage Pepperstone, said the pound was “the scapegoat” of the G10 foreign exchange market, while the UK bond market was “smoked” by the reduction in taxes financed by Kwarteng’s £45 billion debt. package.

“The need for the financing needed to pay the mini budget means we need to see much better growth or higher bond yields to incentivize capital inflows,” Weston said. Targets that the pound could fall below $1.05, for the first time ever, were “freely thrown away”, he added.

After such a dramatic week in the markets, we are expecting a huge week of central bank speakers – will risk rally or will markets go after a response as the ability to gauge risk is so uncertain?

Some thoughts on the business landscape and key talking points#trade #market #USD pic.twitter.com/vUUUR1ig6b

— Chris Weston (@ChrisWeston_PS) September 25, 2022

Kwarteng’s mini-budget caused a rout in UK financial markets on Friday. The pound lost four cents to hit a 37-year low at $1.0856 as the rise in the cost of government borrowing was the biggest in a single day in decades.

The pound falls against the US dollar

“The price of accommodative fiscal policy has been laid bare by the market,” said Sanjay Raja, UK chief economist at Deutsche Bank. He said Kwarteng’s tax cuts added to medium-term inflationary pressures and “raised the risk of a near-term balance of payments crisis”.

“A plan to put public finances back on a sustainable footing will be necessary but not sufficient for markets to regain confidence in an economy running large twin deficits,” Raja said.

The UK’s current account deficit, which includes the balance of trade and net foreign investment and transfer income, had already widened to a record high this year. Adding to this shortfall is the soaring cost of imported energy, which is pushing the pound towards levels that once again make UK assets attractive to overseas buyers.

As of Friday afternoon, Bloomberg’s options pricing model showed there was a 26% chance the pound and dollar would reach parity within the next six months, up from 14% on Thursday.

UK currency and bond markets crashed…
GBP at lowest since 1985
“According to Bloomberg’s option pricing model, the pound has a 26% chance of reaching parity with the greenback within the next six months…” pic.twitter.com/1HvC2uPKYM

— Caroline Hyde (@CarolineHydeTV) September 23, 2022

Nouriel Roubini, the economist who predicted the 2008 financial crisis, warned bluntly that the UK was starting to be valued as an emerging market and heading back to the 1970s.

“Stagflation and possibly the need to go begging for an IMF bailout… Truss and his cabinet have no idea,” he tweeted.

But Paul Krugman, Nobel laureate in economics, pointed out that the depreciation of the pound has actually improved Britain’s net international investment position.

Krugman said a 1970s-style sterling crisis was unlikely to occur unless the Bank of England chose to monetise debt, rather than offset fiscal stimulus with tighter monetary policy.

https://t.co/2ybbKV1Suo

— Paul Krugman (@paulkrugman) September 25, 2022n","url":"https://twitter.com/paulkrugman/status/1573987390875750400","id":"1573987390875750400","hasMedia":false,"role":"inline","isThirdPartyTracking":false,"source":"Twitter","elementId":"5e5d21f3-e66f-4d1e-a722-13e5344103ab"}}'>

I’ve had emails from City economists who agree the balance sheet effects won’t be a problem, but are concerned that the BoE is not, in fact, offsetting the fiscal stimulus – that it is in fact monetizing deficits 1/ https://t.co/2ybbKV1Suo

—Paul Krugman (@paulkrugman) September 25, 2022

Kwarteng tried to play down the financial reaction to Friday’s mini-budget, telling BBC One on Sunday with Laura Kuenssberg that he was focused on boosting long-term growth, not short-term market moves,

“As Chancellor of the Exchequer, I don’t comment on market movements. What I am focused on is developing the economy and making Britain an attractive place to invest,” he said.

The Bank of England is expected to raise interest rates to combat the inflationary impact of the mini-budget as the weaker pound pushes up import costs. Money markets expect UK interest rates to double to over 5% by next summer.

“Tory MPs wonder if Mr Kwarteng has been brilliant or crazy. The markets are saying crazy,” said David Blanchflower, a former member of the Bank’s monetary policy committee.

Blanchflower said he feared Kwarteng’s “reckless attitude” was encouraging investors to “keep selling UK plc”.

Following the mini-budget, the UK Debt Management Office plans to raise a further £72bn before next April, taking the funding mandate in 2022-23 to £234bn.

“Sterling is in the firing line as traders turn their backs on all things British,” said David Madden, market analyst at Equiti Capital. “There is a creeping feeling that the additional government borrowing that is underway will weigh heavily on the UK economy.”

The FTSE 100 fell 2% to a three-month closing low on Friday. Year-to-date, the blue chip index has lost 5% – far less than European or US markets – helped by oil companies and exporters boosted by the weak pound.

“The Chancellor’s high-risk strategy could lead to a deeper correction in the FTSE 100 before the end of the year”, said Charles Archer, financial editor at online trading platform IG. “As monetary policy tightens, defaults on mortgages and debt increase, while investment in growth declines. This could render the mini-budget totally ineffective.

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