Pound hits all-time low

• Sterling extends decline against dollar in Asian trading
• Further slump in UK assets may boost calls for BOE action

Bloomberg

The pound plunged almost 5% to an all-time low after Kwasi Kwarteng vowed to press on with more tax cuts, stoking fears that the new Chancellor of the Exchequer’s fiscal policies will send inflation and government debt soaring.

The slump was sterling’s biggest intraday decline since March 2020, when investor panic over the then-nascent Covid-19 pandemic was roiling markets worldwide.

The pound’s tumble to as low as $1.0350 — fueled by Kwarteng’s comment on Sunday that there’s “more to come” on tax cuts — has sparked calls for aggressive rate hikes from the Bank of England, with some analysts urging emergency action as soon as this week. It’s adding to an already volatile mix of concerns in global financial markets and threatens to engulf Prime Minister Liz Truss’s days-old administration in turmoil as the country grapples with a cost-of-living crisis.

“The pound’s crash is showing markets have a lack of confidence in the UK and that its financial strength is under siege,” said Jessica Amir, a strategist at Saxo Capital Markets in Sydney. “The pound is a whisker away from parity and the situation is going to only worsen from here.”

The currency’s selloff began Friday with the release of the government’s “Growth Plan,” a budget in all but name and the biggest tax giveaway in half a century. Kwarteng scrapped the top level of income tax and cut the basic rate by a percentage point, while also reversing an increase in the National Insurance payroll tax brought in earlier this year. On Sunday, he appeared unperturbed by the ferocious response that sent UK assets tumbling, telling BBC television that he wouldn’t comment on market movements, but when it comes to tax cuts, “there’s more to come.”

Truss will face a rebellion from Tory backbenchers against her tax cuts if the pound falls to parity with the dollar, the Telegraph reported Saturday. Meanwhile, some in the markets are already calling for emergency BOE action to stem the tide, an unprecedented action in modern times that would risk adding to the sense of panic.

Hedge funds had ramped up bullish bets on sterling just days before the crash, with leveraged investors adding 13,488 net long contracts during the week to Sept. 20, the biggest increase since March, data from the Commodity Futures Trading Commission show.

“The scale of the move today means the BOE will be forced into action, at the very least to try and jawbone some stability,” said John Bromhead, currency strategist at Australia & New Zealand Banking Group in Sydney. An “inter-meeting hike is incoming,” with traders already pricing in a 100 basis-point increase by the central bank in November, he said. 

Yields Surge

Yields on UK gilts jumped by a record amount for some maturities on Friday. If maintained, the increase will dramatically inflate the cost of the extra £400 billion ($422 billion) of borrowing the Resolution Foundation estimate is needed over the next five years to fund the growth plan, adding to an interest bill already bulging thanks to sky-high inflation and Bank of England rate increases.

The opposition Labour Party — already enjoying a comfortable lead in the polls — is seeking to capitalize on the policy gulf that’s opened up with the Tories at its annual conference, which began in Liverpool on Sunday. Leader Keir Starmer told the BBC he’d reverse Kwarteng’s most eye-catching measure — the scrapping of the top 45% rate of income tax levied on earnings over £150,000.

“I expect there could be a significant rate hike out of cycle coming,” said Rajeev De Mello, portfolio manager at GAMA Asset Management in Geneva, who has short positions on the pound. “It’s about rolling out the the macro guns to protect your currency. They’ll have to do something. Parity would of course be something to look at now.” 

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