British pound plummets to near parity with U.S. dollar, before bouncing back

The pound fell to its lowest level against the US dollar since 1985 before rebounding on Monday as investors digest the UK government’s plans to boost the economy through tax cuts while borrowing more money for programs.

Traders pushed the British pound down five percent to just above $1.03 on Monday morning, the first day of trading after Chancellor Kwasi Kwarteng – the equivalent of Canada’s Treasury Secretary – revealed the government’s plans to boost economic growth for the year.

Amid sluggish growth and sky-high inflation, the ruling Conservatives plan to cut corporate and personal income taxes to their lowest levels in half a century, while borrowing more money to subsidize consumer food and energy prices.

“The Truss administration is restarting the old Reaganomics playbook with large, unfunded tax cuts for individuals and businesses expected to spur supply-side investment and spur growth,” said Bipan Rai, a foreign exchange analyst at CIBC.

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The pound sold off sharply on the news as traders expressed doubts the plan would work. Prior to Monday, the pound had not been this low in US dollar terms since February 25, 1985, when it was around $1.05 and Margaret Thatcher was in power.

Monday’s early losses came mostly from trading in Asia. As trading began in Europe, the pound began to rally. In the afternoon London time, the pound was just positive on the day after speculation mounted that the Bank of England could announce an emergency, unplanned rate hike.

In the end, that didn’t happen as the central bank merely issued a statement saying it “would not hesitate to change interest rates as much as needed,” which resulted in the pound returning to around US$1.06 -dollar fell.

The seesaw ride speaks to investors’ uncertainty about the UK government’s ability to contain inflation without crashing an already sluggish economy.

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“The British have decided that going back to the 1980s with steroids is the best way to go, and the market is clearly just saying, ‘This isn’t going to work,'” said Rabobank strategist Michael Every.

“The market is now treating the UK as if it were an emerging market. And they are not wrong in terms of policy response and the naivety of believing that you deal with a supply-side shock by stimulating demand rather than supply.”

Strong chance of another decline

Despite Monday’s ebb and flow, experts suggest the pound could still go lower.

“That means easy fiscal policy in times of high inflation [the pound] re-evaluate lower,” Rai said.

The sell-off in sterling raises the likelihood that the Bank of England will have to hike interest rates even more aggressively than before to stem the bleeding. Traders expect an unprecedented 125 point hike when the Bank of England meets in early November.

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The yield on two-year sterling bonds – a bond known as a gilt – rose to its highest level in a decade on Friday before beating that record on Monday. Two-year UK gilts are yielding over 4.5 percent on Monday.

A year ago, the same government bond yielded less than 0.5 percent.

Anything in pounds is dropping like a rock for many valid reasons, but US dollar strength is certainly not helping. As is often the case in times of economic uncertainty, the US dollar is strengthening as foreign investors flock to its perceived safety.

The loonie is trading at 73 US cents as of Monday morning, its lowest level since 2020.

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