LONDON (Reuters) – Sterling fell to record lows on Monday and bonds fell for a second day, with investors penalized for British assets after the government announced its mini-budget last week.
Finance Minister Kwasi Quarting announced Friday that he’s scrapping the country’s highest income tax rate, and a planned increase in corporate tax — all on top of an expensive plan to bolster energy bills for households and businesses.
UK government bond yields surged in response, rising by the most in a single day in decades on Friday, as investors dumped government bonds, while London-listed blue-chip stocks hit their lowest levels since early March.
Kwarteng on Sunday rejected a free fall in the pound, saying his strategy is to focus more on long-term growth rather than the market’s short-term reaction.
In Asian trading on Monday, the pound fell as much as 5% against the dollar at one point to $1.0327, at least its lowest level since the decimal system was introduced in the early 1970s.
Market reaction:
Forex: Against the dollar, sterling was down 1.1% at $1.0735, while against the euro, the pound was down 1.2% at 90.40 pence.
Stocks: It was up 0.5% in early trade Monday, while Capital Average was down 0.7%.
Bonds: Two-year bond yields rose 43 basis points at 4.42%, while 10-year yields rose 28 basis points to 4.11%.
comments:
Mohamed El-Erian, Chief Economic Adviser, Allianz:
โThere are only two options for the country, and one of them (Kwarteng) adjusts his package. This is not about structural reforms that boost growth and productivity, markets are going to like it, and it is not about energy stability, this is about the additional tax cuts that have been introduced and that would surprise markets on Friday.”
โSo the first option is that he resets their package, which is politically difficult but economically required. The second option is he leaves it to the BoE in which case the BoE will have to raise it in an emergency meeting because they don’t. We meet again until November But that in and of itself goes against it. Again a picture of driving a car with the Chancellor’s foot on the accelerator and the Governor’s foot on the brakes. This is not a good way to propel the UK economy.”
YOU-NA PARK-HEGER, Currency Strategist, COMMERZBANK, Frankfurt:
โLast week’s BoE meeting minutes made it clear that in its fight against inflation, the BoE is putting some hope in fiscal policies. Measures such as the energy price cap, which will come into effect in October, may dampen inflation pressure. And thus ease pressure on the BoE. To fight inflation in a more specific way.
โHowever, the sterling moves recorded on Friday and especially this morning show that this is not that easy. The mini-budget offer has been received very poorly by the markets – the pound has literally collapsed. The significant tax cuts announced by the Chancellor of the Exchequer are causing concerns about the markets Currencies due to high government debt.
Sami Char, Chief Economist, Lombard Audier, Geneva:
โThis does not look like a currency crisis, with a depreciating currency exacerbating the situation. Sterling needs to fall due to deficits and uncertainty about what the BoE will do, but at some point, it will drop to a level where attractive yield prospects improve prospects economic and financial flows.
Michael Kell, Strategist, RABOBANK Singapore
โThe British decided that going back to the ’80s on steroids was the best way to go, and the market is clearly just saying: ‘This won’t work’ on steroids.
“The market is now treating the UK as if it were an emerging market. They are not wrong about the policy response and the naivety of thinking that boosting demand rather than supply is how to deal with a supply side shock.”
Shvali Sachdev, Head of Fixed Income and Commodities, Asia, BNP PARIBAS WALTH MANAGEMENT, SINGAPORE
โIt is interesting to see the G10 currency weaken in anticipation of a rally. It makes you aware that the market is not entirely confident in the ability of the UK government to be able to fund its fiscal plans.
“Its computation means that something has to be offered, whether it’s on higher price terms, or a weaker GBP. And I think the market is taking a very calculated bet that this will be the case.”
Paul McKeill, Global Head of Forex Research, HSBC, Hong Kong
โThe movements over the past two trading days have been very violent.
โYou usually think of a very strong fiscal package that raises interest rate expectations that should be positive for the currency, but this time we don’t see it. We’re seeing just the opposite.
“What has happened in the last 48 hours or so, it is a powerful reminder about how suddenly the drivers of exchange rates can change.”
Kate Jukes, Head of Collaboration Strategy, At-Large Society, London
โMarkets tend to override and I won’t over-explain fall this morning.
“But there are two points. The first is the loss of confidence in British fiscal policy and that is not going to help the pound. The second is that the mini-budget has allowed the pound to be a short option against the dollar.”
Lee Hardman, Currency Analyst, Moov, London
“The massive market reaction to the UK government’s fiscal stimulus plans sends a clear signal that market participants have lost confidence in the appropriateness of the UK’s domestic policy settings.”
Paul Dallis, Head of UK Economy, Capital Economics, London
“The further drop in sterling in early trade means we are now at the point where the Bank of England needs to step in in order to take back the lead. There are two ways this could go.”
“First, Governor Bailey may come out this morning to confirm the Bank’s commitment to the 2% inflation target and provide a clear signal that he intends to raise interest rates aggressively at the next policy meeting in early November.”
โIf this is coordinated with a message from the government that it is committed to long-term fiscal discipline and will present plans to make clear how it intends to keep the public debt position stable in the wake of last weekโs fiscal bragging, then some could ease downward pressure on the pound.โ
