UK markets have been shaken to the core by the new UK government’s tax plans and the Bank of England promise to take action did not assuage concerns or halt the pound’s slide.
Market participants had been split as to whether BoE needed to deploy emergency monetary policy to help stabilise the UK and a plummeting pound which lost 5% this morning to hit a record low of $1.03 against the dollar.
Sterling recovered to around $1.09 amid speculation that the BoE was going to make a more aggressive move and then fell to $$1.06 when the central bank decided not to hold an emergency meeting to set new rates.
It said that it would change them “by as much as needed” when it meets in November.
However, Governor Andrew Baily noted that the bank is monitoring developments in financial markets “very closely.”
He said policy makers “will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term.”
Meanwhile, the Treasury said it will set out plans to cut debt in November.
The current bout of market volatility is in response to Chancellor Kwasi Kwarteng’s new economic strategy, which involves £45bn of tax cuts funded by extra borrowing. This includes the biggest tax cuts in 50 years.
Prime Minister Liz Truss government also plans to spend £150bn to subsidise energy costs for consumers and businesses.
A large portion of this borrowing is to be financed by gilts. Unlike the big tax cuts in the 1980s, Kwarteng is borrowing tens of billions of pounds to fund his plans.
There are fears that together. these measures will fuel inflation and increase borrowing at a time of rapidly rising interest rates.
As Gilles Moëc, group chief economist at AXA Investment Managers, said, “The Bank of England was isolated in choosing not to do a “jumbo hike” last week.” It raised interest by 0.5 percentage points after a third successive 0.75 percentage point rate increase by the US Federal Reserve a day earlier.
He added, “They may well have to deliver one very soon. The fact that the market did not like the latest fiscal policy announcements in the UK is an understatement. We reiterate our view that it’s a very adventurous package. The recipes of 1980 don’t work well in the 2020s.”
Tom Stevenson, investment director for personal investing at Fidelity International at Fidelity, noted, “When added to the enormous cost of the already announced energy price support package, the unexpectedly sweeping income tax and stamp duty measures announced last week have left investors, at home and abroad, asking: who’s going to pay,?”
He added, “Faced with that uncertainty, investors are demanding more compensation for the risk of lending money to the UK government- the yield on a 10-year gilt has jumped to 3.8%. And they are discarding the currency; the pound has lost a quarter of its value against the dollar this year.”
