Currency markets reacted to new UK Chancellor Kwasi Kwarteng’s mini-budget on Friday with a rapid sell-off in sterling, sending the pound’s value plummeting against the dollar and other currencies.
Markets were spooked by government plans to cut taxes by £45billion without significant spending cuts. This means government borrowing will have to increase to cover state spending – although Prime Minister Liz Truss says the jolt to the economy will boost tax revenue.
The 3.6% fall in the value of the pound sterling on Friday was the fifth worst one-day fall in four decades. It was only overcome by market adjustments to COVID-19, a significant episode of the 2009 financial crisis, Black Wednesday (when the pound was expelled from the European exchange rate mechanism) and the vote on the Brexit in 2016. And the drop since Truss took office 20 days ago is already bigger than during the entire tenure of his immediate predecessors Boris Johnson and Theresa May.
At one point on Monday, the pound fell to an all-time low against the dollar, although it rallied later in the day as markets priced in a sharp rise in Bank of India interest rates. England.
The pound’s fall against the dollar and other currencies is already increasing borrowing costs for the government, with 10-year gilt yields soaring since the announcement of the tax cuts. At 95.3%, the UK’s debt-to-GDP ratio looks relatively healthy compared to most other countries in the G7 group of advanced democracies. But it is set to get worse as the gap between tax revenue and spending widens.