Sterling sinks to new low as ‘mini budget’ shatters investor faith in UK markets

By Amanda Cooper and David Milliken

LONDON (Reuters) – The pound plunged to a record low against the dollar early on Monday and British bond prices collapsed as fears mounted over the new government’s fiscal plan, unleashing calls for an emergency Bank of England rate hike to restore confidence.

New finance minister Kwasi Kwarteng sent sterling and government bonds into freefall on Friday with a so-called mini-budget that was 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 by as much as 5% against the dollar to touch $1.0327, its weakest since at least the introduction of decimalisation in the early 1970s, before it pared losses in European trading.

But there was even more pressure in the gilt market, sending borrowing costs surging.

Having risen on Friday by the most in a single day in decades, bond yields on two-year gilts jumped again on Monday by as much as 53 basis points to a high of 4.55%. The yield has risen by around an entire percentage point in the last two trading days alone, reflecting investors’ lack of confidence in the government’s ability to fund its tax cuts.

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

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

TREASURY ORTHODOXY

Truss was elected as prime minister earlier this month by a vote of the Conservative Party’s 170,000 members – not the broader electorate – vowing to reignite economic growth through tax cuts and deregulation, even if it favours the wealthy over the poorest households.

Her pledge to end so-called “Treasury Orthodoxy” and go for growth marks a step change in British financial policy, harking back to 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,” one veteran Conservative party source said, declining to be named. “We did something structural, short term, that will have seismic and positive long term benefits.”

However, the scale of the market turbulence has started to rattle some in the party, with one lawmaker saying mainstream Conservatives were getting “very worried”, as constituents emailed their local politicians to express alarm.

The lawmaker asked not to be named.

Rachel Reeves, a former economist at the Bank of England (BoE) who is now the financial policy chief for the opposition Labour Party, said she was “incredibly worried” by the reaction of markets and Nicola Sturgeon, the first minister in Scotland, called for the UK parliament to be recalled.

Investors and analysts were more direct.

“The British have decided that going back to the 1980s on steroids is the best way to go, and clearly the market is just saying: ‘That’s not going to work’,” Michael Every, Rabobank strategist, said.

“The market is now treating the UK as if it’s an emerging market. And they’re not wrong in terms of the policy response and the naivety of thinking that boosting demand rather than supply is how you deal with a supply-side shock.”

The pound had rebounded to $1.08 as of 1144 GMT, but there was no sign of recovery in gilts.

DOOMSDAY CULT

Paul Donovan at UBS said investors seemed “inclined to regard the UK Conservative Party as a doomsday cult”.

Markets currently show investors are placing an 88% chance on the BoE raising rates by a percentage point to 3.25% at its next meeting in November, according to Refinitiv data.

The debate between some economists was whether an emergency rate hike would sow yet more panic, or calm markets.

Andrew Sentance, a former BoE policymaker, told Sky News he did not advocate an emergency meeting. “I think that would add to the sense of nervousness and panic rather than calming it down,” he said.

Further highlighting the extent to which investors have punished UK assets, the difference in the 10-year borrowing costs for the British and German governments exploded to its widest since 1992, when the UK crashed out of the European Exchange Rate Mechanism.

British government bond prices are now on track for their biggest slump of any calendar month since at least 1957, according to a Reuters analysis of Refinitiv and BoE data.

In response to that statistic, Paul Johnson, the head of the Institute for Fiscal Studies, attacked the government’s decision to ignore the usual rules. “This will cost billions,” he said on Twitter (NYSE:). “Economic and fiscal constraints are real. It’s not just ‘Treasury orthodoxy'”.

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