The decline partly reflects the strength of the US dollar, which has been boosted by higher interest rates. But it has also fallen against many other currencies, indicating specific concerns about the UK economy.
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The pound hit a record low of $1.03 in early Asian trade on Monday, before regaining some ground to stabilize around $1.08 – still well below where it was on Friday morning before the government unveiled its “mini-budget”.
The decline comes as global markets falter and recession fears grow in many geographies. In the US, the Federal Reserve raised interest rates last week in its ongoing push to curb high inflation. It was the fifth interest rate increase of the year and the third in a row by three quarters of a percentage point. That rattled Wall Street, and on Friday the Dow Jones industrial average had closed below 30,0000, to its lowest point since 2020.
“We have to get inflation behind us,” Federal Reserve Chairman Jerome H. Powell said last week. “I wish there was a painless way to do it. There isn’t.”
The major U.S. indexes fell in early afternoon trading Monday, with the Dow down about 275 points, or 0.9 percent, and the S&P 500 down 0.9 percent. The technology-heavy Nasdaq fell 0.3 percent.
The Bank of England said on Monday that it is “monitoring developments in financial markets very closely in light of the significant repricing of financial assets.”
In a statement, the central bank said its monetary policy committee would make a “full assessment” of the impact of the government’s actions and the pound’s fall at its next meeting, which is scheduled for November.
“The MPC will not hesitate to change interest rates as needed to bring inflation back to the 2% target sustainably over the medium term, in line with its mandate,” it said.
The pound’s fall comes about two months after the euro reached parity with the dollar for the first time in almost two decades. The war in Ukraine has disrupted food supplies and sent energy costs skyrocketing around the world and especially in Europe. That, combined with the Fed’s rate hike, has made the dollar a relatively safer bet for investors.
Mike Riddell, senior fixed income portfolio manager at Allianz Global Investors, said the pound’s decline was not necessarily a symptom of European recession. Rather, investors are becoming skeptical about Britain’s ability to fight inflation.
“The scary thing is that the global economy has yet to feel the impact of all the interest rate hikes we’ve seen around the world in recent months, because it takes about a year for changes in monetary policy to have an impact on the economy,” he said in an e-mail mail.
Of course, a weaker currency does not necessarily reflect a weak economy. In many cases it can be beneficial, for example making British exports cheaper for US consumers – and so a weak pound will boost overseas sales for export-oriented companies. But that means all dollar denominations, such as energy costs, will increase for consumers.
That’s good news for American tourists in Britain, who suddenly find their dollars go a lot further. It is not good news for many British households, who are already facing sky-high energy bills and inflation of 10 per cent. They will find that the cost of imported goods and services will rise, including everything from fuel to vehicles to food on plates – in 2020 the UK imported 46 per cent of the food it consumed.
On Friday, Kwasi Kwarteng, the new finance minister, announced a package of tax cuts worth 45 billion pounds ($48 billion), the biggest shake-up to the tax system in 50 years. The top 45 percent income tax rate was cut, the cap on bank bonuses will be scrapped, and taxes on home purchases were cut – moves that will mainly help more affluent citizens in the hope that they will increase spending.
While the new Prime Minister, Liz Truss, had promised tax cuts during her leadership campaign, the scale of the cuts still shocked many economic observers.
“In the current economic environment, it’s a big game,” wrote Thomas Pope, an economist at the Institute for Government. It is a major shift away from the policies of Truss’s predecessor, Boris Johnson, who last year had announced tax increases to pay for fighting the pandemic.
The new UK government hopes that by cutting taxes and regulations it will be able to generate growth that will help fund public services and eventually pay down the debt.
John Hardy, head of currency strategy at Saxo Bank, said the pound fell because the government’s calculations did not reassure investors.
“It’s a numbers game and their numbers don’t add up,” he said.
Investors are looking at where inflation is heading and at the UK’s balance sheet.
“They say, ‘I don’t want to own British paper because they don’t play responsibly,'” Hardy said.
Truss, who is only three weeks into his new job, has defended the tax cut bonanza.
In a recent interview, CNN’s Jake Tapper told Truss that British opposition parties are portraying her plans as “recklessly increasing the deficit” and that President Biden is “essentially saying your approach is not working.”
Last week, Biden tweeted: “I’m tired of trickle-down economics. It’s never worked.” He was referring to the supply-side economics made famous by President Ronald Reagan, which Truss’s approach resembles.
In the interview, Truss replied: “The UK has one of the lowest levels of debt in the G-7. But we have one of the highest tax levels. Currently, we have a 70-year high tax rate. And what I am determined to do as Prime Minister, and what the Chancellor is determined to do, is to make sure that we encourage businesses to invest. And we also help ordinary people with their taxes.”
Truss continued: “That’s why I don’t feel it’s right to have higher national insurance and higher corporation tax, because it will make it harder for us to attract the investment we need in the UK. It will be more difficult to generate the new jobs. “
Rachel Lerman in Washington contributed to this report.