The British pound has fallen to a record low against the dollar as markets react to the UK's biggest tax cuts in 50 years. In early Asia trade, sterling fell close to $1.03 before regaining some ground to stand.
Financial market participants are concerned about such a decline of the British pound, which may soon reach a consensus with the U.S. dollar, as happened with the euro.
We have analyzed the causes and likely consequences of such a decline of the British pound against the U.S. dollar.
UK announces $49B in tax cuts, sending pound crashing
One of the main reasons for the rapid decline of the British pound is the announced tax cuts in the kingdom.
British Chancellor Kwasi Kwarteng unveiled Friday, Sep. 23, a mini-budget in parliament comprised of a debt-financed package of £45 billion ($49 billion) in tax cuts – the biggest round in 50 years.
Kwarteng told parliament his fiscal statement was “one of the most significant interventions the British state has ever made,” and the package would “turn the vicious cycle of stagnation into a virtuous cycle of growth.”
The markets immediately reacted negatively to this and the pound started to decline actively. On the eve of the weekend, the pair $GBPUSD was trading at 1.07, and on Monday after the opening of trading, it dropped to 1.03.
The $GBP/USD dropped on Monday, September 26, to 1.038, it's all-time low.
The scale of the tax cuts, funded through government borrowing, while the government is already increasing spending, also funded through government borrowing, to deal with the energy crisis triggered concern among experts and financial markets.
The headline tax cut announced was the abolition of the top rate of tax, which was 45% for those earning more than £150,000 per year.
The corporation tax will remain at 19% with a planned increase to 25% now scrapped. A planned increase in alcohol duty was also scrapped.
Stamp duty, the tax paid when people buy property, will be cut. It will be done by doubling the exemption level, the point above which it has to be paid, from £125,000 to £250,000 and from £300,000 to £425,000 for first-time buyers.
The British pound is in danger
Following Kwarteng’s announcement, the pound sank to a 37-year low against the US dollar, with the sterling falling below $1.10 for the first time since 1985. So far this year, the pound has declined 17% against the greenback.
It also fell 1.1% against the euro, and the FTSE 100 share index dropped 2.3% following the announcement.
Unlike Margaret Thatcher’s tax cuts in the 1980s, which were funded through public spending cuts, Kwarteng’s package is funded through increased government borrowing, which is an approach that has less in common with Thatcher and more with former US President Ronald Reagan.
As a result of investors selling UK government bonds, the cost of government borrowing has increased. A year ago, the two-year cost of borrowing was 0.4% – it is now 3.95%.
The cost of government borrowing, according to Bloomberg.
The Bank of England warned Thursday that the UK could already be in recession. It also increased interest rates, with the level now standing at 2.25%. Markets are expecting further interest rate hikes as a result of the announcement to keep inflation under control.
What should investors and traders expect?
Investors all around the world trade huge amounts of foreign currency every day. The rate at which investors swap currencies also determines what rate people get at the bank, post office or foreign exchanges.
Based on this, a fall in the pound affects household finances too.
If the pound is worth less, the cost of importing goods from overseas goes up.
For example, as oil is priced in dollars, a weak pound can make filling up your car with petrol more expensive. Gas is also priced in dollars.
Technology goods, like iPhones, that are made abroad, may get more expensive in UK shops. Even things that are made in the UK but from parts that are bought abroad can get much more expensive.
If the pound stays at this low level against the dollar, imports of commodities priced in dollars, including oil and gas, will be more costly.
But back to the expectations of investors and traders…
The British pound regained some of its losses by the end of Monday, trading at 1.08 against the US dollar. However, the situation could repeat itself if the BoE's aggressive monetary policy continues, and the regulator urgently raises the rate again and again.
The currency pair $GBPUSD may fall again to local lows amid a strengthening dollar.
Reason two is the UK is looking less and less like a safe haven. The new government is cutting taxes and spending up big rather than paying back debt, and investors don’t like it.
Well, if the British Treasury's ideas to cut taxes for citizens fail to materialize, the pound could reach parity with the dollar, as it did with the euro. This could happen as soon as this autumn, but the pound still has time to recover.
Summary
- The British pound has fallen to a record low against the dollar as markets react to the UK's biggest tax cuts in 50 years.
- One of the main reasons for the rapid decline of the British pound is the announced tax cuts in the country of the kingdom.
- If the British Treasury's ideas to cut taxes for citizens fail to materialize, the pound could reach parity with the dollar, as it did with the euro.
