Traders dumped the pound on fears looming tax cuts will worsen Britain’s already-shaky economy.
Brendan McDermid/Reuters
The British pound tumbled to an all-time low against the US dollar on Monday.
It plunged on fears impending tax cuts will worsen inflation and prompt faster interest-rate hikes.
The UK economy is already battling slower growth and a cost-of-living crisis.
The pound plunged to an all-time low of 1.035 against the US dollar on Monday as traders bet that looming tax cuts could fuel inflation, prompt faster interest-rate hikes, and undermine Britain’s already-shaky economy.
Chancellor Kwasi Kwarteng said Friday that he intends to scrap Britain’s top income-tax rate of 45%, nix a scheduled rise in the national insurance rate, and abolish the stamp duty on property purchases of under £250,000. On Sunday, Kwarteng hinted there could be even more tax cuts coming.
His tax cut plan is aimed at boosting the ailing UK economy and reducing the risk of a severe recession. However, it’s sparked fears of faster price increases, government debt that’s out of control, and a worse downturn.
Some investors don’t believe the impending tax cuts will be fully-funded, meaning the UK government’s debt pile will grow. Critics also worry the cuts will fuel already-high inflation — which hit a 40-year peak of 10.1% in July — by boosting demand.
The Bank of England has already hiked its base rate to 2.25% from near-zero at the start of 2022, in a bid to slow price increases by encouraging saving over spending and raising borrowing costs. However, as Kwarteng’s tax plan rocks markets, the central bank could be forced to raise rates even more aggressively, risking “stagflation” — where the economy slows sharply or contracts, unemployment rises, and inflation remains stubbornly high.
The dollar’s appreciation and the pound’s slump this year partly reflect the US Federal Reserve’s series of aggressive interest-rate hikes, which has lifted the federal funds rate from virtually nothing to a range of 3% to 3.25%. This has spurred some investors to swap pounds for dollars in pusuit of better returns.
Meanwhile, the UK’s economic outlook is being clouded by Russia’s invasion of Ukraine, which has disrupted global energy supplies and driven up food and fuel prices. Brits are set for a lengthy cost-of-living crisis, given prices have jumped across the board and energy bills are set to skyrocket this winter.
The UK economy shrank last quarter, and risks remain of persistently high inflation and unemployment. There will now also be a larger and more expensive government debt load, and a weaker pound making imports more expensive.
So it’s little wonder investors are fleeing the pound.