Pound plunges to all-time low as UK economic plan spurs investor exodus

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TOKYO - The British pound tumbled to a record low on Monday, prompting speculation of an emergency response from the Bank of England (BOE), as confidence evaporated in Britain’s plan to borrow its way out of trouble, with spooked investors piling into US dollars.

The pound dived as much as 4.9 per cent to an all-time nadir of US$1.0327 before stabilising at around US$1.05405, 2.9 per cent below the previous session’s close.

It dropped 3.6 per cent on Friday, when new finance minister Kwasi Kwarteng unveiled historic tax cuts funded by the biggest increase in borrowing since 1972.

Against the Singapore dollar, the pound sank 2.89 per cent to $1.5079 as at 11.55am, and is now down about 17 per cent this year.

“Sterling is getting absolutely hammered,” said Mr Chris Weston, head of research at Pepperstone.

“Investors are searching out a response from the Bank of England. They are saying this is not sustainable, when you have got deteriorating growth and a twin deficit.”

The pound’s searing drop helped boost the safe-haven US dollar to a new two-decade peak against a basket of major peers. The dollar index - whose basket includes sterling, the euro and the yen - reached 114.58 for the first time since May 2002 before easing to 113.73, 0.52 per cent higher than the end of last week.

The euro also touched a fresh 20-year trough to the dollar on simmering recession fears, as an energy crisis extends towards winter amid an escalation in the Russia-Ukraine war. A weekend election in Italy was also set to propel a right-wing alliance to a clear majority in Parliament.

The dollar built on its recovery against the yen following the shock of last week’s currency intervention by the Japanese authorities, as investors returned their focus to the contrast between a hawkish United States Federal Reserve and the Bank of Japan’s insistence on sticking to massive stimulus.

Mr Kwarteng scrapped the top level of income tax and cut the basic rate by a percentage point, while also reversing a rise in the National Insurance payroll tax brought in earlier this year. On Sunday, he appeared unperturbed by the ferocious response that sent British assets tumbling, telling BBC television that he would not comment on market movements, but when it comes to tax cuts, "there is more to come".

"We have only been here 19 days," Mr Kwarteng said. "I want to see, over the next year, people retain more of their income, because I believe that it is the British people that are going to drive this economy."

On Friday, yields on British government bonds soared, by a record amount on some maturities, as investors punished the minister for his unapologetic dash for growth.

If maintained, the move in yields will dramatically inflate the cost of the extra £400 billion (S$616 billion) of borrowing that the Resolution Foundation think-tank estimates is needed over the next five years to fund the plan, adding to an interest bill already bulging thanks to sky-high inflation and BOE rate increases.

"With broad unfunded spending on the fiscal side unmatched by monetary policy to offset the inflationary impulse, the currency is likely to weaken further," Goldman Sachs analysts wrote in a note to clients on Friday.

The market moves this week could have huge implications. The opposition Labour Party - already enjoying a comfortable lead in the polls - is seeking to capitalise on the policy gulf that has opened up with the Tories at its annual conference, which began in Liverpool on Sunday. Leader Keir Starmer on Sunday told the BBC he would reverse Mr Kwarteng's most eye-catching measure - the scrapping of the top 45 per cent rate of income tax levied on earnings over £150,000.

The Telegraph reported on Saturday that British Prime Minister Liz Truss will face a rebellion from Tory backbenchers against her tax cuts if the pound falls to parity with the dollar. Meanwhile, some in the markets are already calling for emergency BOE action to stem the tide, an unprecedented action in modern times that would risk adding to the sense of panic.

After Mr Kwarteng's speech on Friday, traders fully priced 120 basis points of additional rate hikes from the BOE by its Nov 3 meeting - more than double the size of the move announced on Thursday that took rates to 2.25 per cent.

If the weekend break has brought some calm, and moves start to retrace on Monday, that will buy Ms Truss and Mr Kwarteng time to try to seize back the agenda. This would increase the importance of the Tory party conference next week, which now risks turning from a coronation of the new government into a chance to restore already-battered credibility.

But the outlook from many in the market is far from rosy. Last week's turmoil led to more predictions, including from former United States Treasury secretary Lawrence Summers, that the pound will decline below parity with the dollar.

Bloomberg's options pricing model now shows a one-in-four chance that the pound will reach US$1 in the next six months, up from 14 per cent on Thursday. REUTERS, BLOOMBERG

• Additional information from The Straits Times

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