Pound drops to new low as ‘mini budget’ shatters investor confidence in UK markets

  • The pound briefly touched a record low against the dollar
  • The gilts keep falling apart

LONDON, Sept 26 (Reuters) – The pound plunged to a record low against the dollar on Monday and British bond prices tumbled as fears mounted over the new government’s budget plan, sparking calls for a hike in Bank of England rate emergency to restore confidence.

New finance minister Kwasi Kwarteng sent the pound and government bonds into a tailspin on Friday with a so-called mini-budget designed to grow the economy by funding tax cuts with huge increases in government borrowing.

As trading resumed in Asian markets on Monday, the pound plunged as much as 5% against the dollar to touch $1.0327, its lowest level since at least the introduction of decimalisation in the early 1970s , before cutting losses in European trade. , Learn more

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But there was even more pressure in the gilt market, driving up borrowing costs.

After rising the most in a single day on Friday in decades, two-year gilt bond yields jumped again on Monday by 53 basis points to a high of 4.55%. The yield rose about a percentage point over the past two trading days, reflecting investors’ lack of confidence in the government’s ability to fund its tax cuts.

Mohamed El-Erian, chief economic adviser at Allianz, said the central bank would have no choice but to raise rates if Prime Minister Liz Truss’ government did not back down.

“And not by little, 100 basis points, a full percentage point to try to stabilize the situation,” he told BBC Radio.

TREASURY ORTHODOXY

Truss was elected Prime Minister earlier this month by a vote of the 170,000 members of the Conservative Party – not the wider electorate – promising to revive economic growth through tax cuts and deregulation, even if that favors the rich over the poorest households.

His promise to end the so-called “Treasury orthodoxy” and aim for growth marks a sea change in British financial policy, reminiscent of the Thatcherite and Reaganomics doctrines of the 1980s.

Kwarteng has so far declined to comment on the market turmoil, and a person close to the finance minister said he was unmoved by the reaction.

“Markets go up and down,” said a veteran Conservative Party source, who spoke on condition of anonymity. “We did something structural, short-term, that will have long-term seismic and positive benefits.”

However, the scale of the market turmoil has started to rattle some party members, with one lawmaker saying mainstream conservatives were getting “very worried”, as voters emailed their local politicians expressing concern.

The lawmaker asked not to be named.

Rachel Reeves, a former economist at the Bank of England (BoE) who is now chief financial policy officer for the opposition Labor Party, said she was “incredibly worried” about the market reaction and Nicola Sturgeon, the Scottish first minister , called for the British parliament to be recalled.

Investors and analysts have been more direct.

“Brits decided that going back to the 1980s on steroids was the best way forward, and clearly the market is just saying, ‘That won’t work,'” Rabobank strategist Michael Every said.

“The market is now treating the UK as if it were an emerging market. And they are not wrong in terms of policy response and naivety to think that driving demand rather than supply is the how you handle a supply-side shock.”

The pound had rebounded to $1.08 by 11:44 GMT, but there was no sign of a recovery in gilts.

CULT OF DEATH

UBS’s Paul Donovan said investors seemed “inclined to see Britain’s Conservative Party as a doomsday cult”.

Markets are currently showing investors are placing an 88% chance that the BoE will hike rates by one percentage point to 3.25% at its next meeting in November, according to Refinitiv data.

The debate among some economists was whether an emergency rate hike would cause even more panic or calm markets.

Andrew Sentance, a former BoE policymaker, told Sky News he was not advocating an emergency meeting. “I think it would add to the feeling of nervousness and panic rather than calm it down,” he said.

Further underscoring how much investors have punished UK assets, the difference in 10-year borrowing costs for the UK and German governments has exploded to its highest level since 1992, when the UK collapsed from the mechanism. European exchange rate.

UK government bond prices are now on course for their biggest fall in any calendar month since at least 1957, according to a Reuters analysis of data from Refinitiv and the BoE. , (.FTSE)

In response to this statistic, Paul Johnson, the head of the Institute for Fiscal Studies, attacked the government’s decision to ignore the usual rules. “It will cost billions,” he said on Twitter. “The economic and fiscal constraints are real. It’s not just ‘Treasury orthodoxy’.”

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Written by Kate Holton and Amanda Cooper; additional reporting from Elizabeth Piper, Kylie MacLellan, Andy Bruce and Harry Robertson; Editing by Hugh Lawson and Mark Potter

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