Good morning and welcome to our rolling coverage of business, the world economy and financial markets.
The small budget and the Truss government’s tax cuts have hit international confidence in the UK hard, and the pound is paying the price.
Sterling fell to a new all-time low against the dollar in Asia-Pacific trading, extending Friday’s losses and approaching parity.
Investors were stunned by the massive tax cuts announced in Kwasi Kwarteng’s mini-budget – with the UK chancellor pledging more tax cuts over the weekend.
Sterling tumbled nearly 5 percent to near $1.0327 at one point, hitting its lowest level since at least decimalisation in 1971, as confidence in Britain’s economic management and assets evaporated, Reuters data showed.
The currency is still down 7% in two sessions, even after falling to as low as $1.05 when traders arrived at their desks in New York City this morning.
It could be a volatile day, with fears of a global recession also hitting markets.
Naeem Aslam, Chief Market Analyst Aihua Tradingmade a scathing assessment of the situation:
Sterling has taken an absolute beating today in this week’s trade, with traders already picking up where they left off on Friday.
The pound looks like an emerging market currency, especially when you look at the price of the pound a few months ago and compare it to where it is now.
Marc Chandler, chief market strategist at Bannockburn Global Forex, called the currency’s record slump “incredible.” He believes there is bound to be speculation about an emergency Bank of England meeting and rate hikes.
Sterling has fallen nearly 10% so far this month on anxiety about a looming recession and a surge in borrowing needed to fund Kwarteng’s £45bn giveaway.
Liz Truss plans to fundamentally reshape the UK economy with more tax cuts and less regulation, Kwarteng told BBC One’s Sunday programme yesterday with Laura Kuenssberg
“There is more to be done,” said Kwasi Kwarteng, who declined to set limits on the amount of public debt that could be incurred in the process.
Chris Weston, head of research at brokerage Pepperstone, said the pound was the “whip” of the G10 foreign exchange market, while the UK bond market was “smoked”.
Weston told clients:
“Investors are looking for a response from the Bank of England. They say it’s not sustainable because of worsening growth and twin deficits.”
“The need for funding to cover small budgets means we need to see better growth or higher bond yields to stimulate capital inflows,” Weston said.
The City of London is now watching whether the Bank of England takes steps to calm the market.
Friday afternoonDeutsche Bank analyst George Saravelos said the Bank of England should raise interest rates sharply between a meeting as early as this week to calm markets and restore credibility. …
Here is the full story:
9am BST: German Ifo Business Climate Index
1.30pm BST: Chicago Fed US Economic National Activity Index
2pm BST: ECB President Christine Lagarde to attend European Parliament Economic and Monetary Affairs Committee in Brussels
According to Bloomberg calculations, it is increasingly likely that the pound will fall against the dollar this year, based on options market pricing.
Here are the details:
GBP/USD implied volatility points to a 60% chance of spot prices reaching 1.00 by the end of the year – based on spot trading at $1.0552 – compared with 32% on Friday.
Markets are also expecting extreme volatility, with three-month implied volatility for GBP/USD surging 4.31 percentage points to 20.05% on Monday. This is fast approaching the high of 20.62% reached during the 2020 pandemic collapse.
A surge in UK gilt yields has pushed up borrowing costs to a 12-year high – at a time when the UK government is planning to borrow heavily.
will be expensive…
Paul Donovan, chief economist at UBS Global Wealth Management, said investors seemed inclined to view Britain’s Conservative Party as a doomsday cult.
In his morning remarks, Donovan delivered an absolutely drastic verdict on the government’s plans:
A global signal from the UK’s micro-budget issues. MMT has been cornered and beaten by the bond market. Advanced-economy bond yields shouldn’t surge like UK gilt yields.
It also reminds investors that modern politics has produced parties that are more extreme than voter or investor consensus. Investors seem inclined to view Britain’s Conservative Party as a doomsday cult.
Tax cuts are unlikely to give the UK a meaningful medium-term boost (supply constraints in the UK economy are more about health and education). Short-term “sugar high” is likely, but may be limited. The rational response of high-income earners is to increase their savings to prepare for future tax increases.
Mohamed El-Erian, an adviser to financial services giant Allianz, said Prime Minister Kwasi Kwarteng was wrong to relax in the market’s reaction to the small budget.
El-Erian, who is also principal at Queen’s College in Cambridge, said Kwarteng should be watching closely, otherwise “what’s happening in the market could snowball and undermine what he’s trying to do”.
El-Erian told the TODAY programme that movements in yields and the pound would translate into “stronger stagflation winds” that run counter to Kwarteng’s efforts to drive growth.
El-Erian added that the Bank of England should raise interest rates by 1 percentage point if UK Finance Minister Kwasi Kwarteng doesn’t “realign” the small budget to scrap the extra tax cuts introduced, surprising the market.
If the chancellor ignores his plan, the Bank of England should raise interest rates in an emergency meeting. But that also goes against Kwarteng’s plan.
El-Erian has warned that driving a car with the chancellor’s foot on the gas and the banker’s foot on the brakes is not a good way to boost the UK economy.
But even so, El-Erian said he would raise rates by a percentage point if the chancellor didn’t change course.
“If I were the governor and the prime minister didn’t revise his plan, I would raise rates instead of a little bit, 100 basis points, a full percentage point to try to stabilize the situation,”
He also wrote about his concerns for the Guardian today, here:
Economist Sean Richards suggested that the Bank of England should stop its plan to start selling some of the UK’s gilts.
The Bank of England has decided to start unwinding its quantitative easing (QE) programme by selling £80bn of gilt bonds over the next few months. However, this will add to selling pressure in the bond market.
Pause of quantitative tightening (QT) may calm markets…
…and they are certainly far from peaceful now, as British gilts are being culled:
Shadow chancellor Rachel Reeves accused Kwasi Kwarteng of “stoking the flames of sterling devaluation” by suggesting further “unfunded” tax cuts.
Reeves told BBC Radio 4’s Today programme:
“I think a lot of people were hoping things would calm down over the weekend, but I do think the prime minister was a little bit fanciful on Sunday suggesting there could be more stimulus, more unfunded tax cuts, and that caused the pound to fall to 50% overnight. A record low against the U.S. dollar.”
UK bonds continue to tumble – pushing yields higher.
Two-year gilt yields, a measure of short-term borrowing costs, have reached 4.5 percent, double their mid-August level.
Here’s Reuters’ mission:
British government bond prices tumbled at the start of trading on Monday after sterling hit a record low against the dollar overnight, pushing yields to their highest in more than a decade.
The five-year Treasury yield rose more than 40 basis points to 4.503%, the highest since October 2008, while the two-year yield rose more than 50 basis points to 4.533%, the highest since September 2008.
UK government bonds sold off sharply in early trade – again adding to losses following Friday’s small budget announcement.
Yields, or interest rates, on British two-year, five-year and 10-year government bonds have all soared.
Yields (which rise when prices fall) measure interest rates on bonds – so this suggests the UK’s borrowing costs have risen, just as it needs to borrow an extra £72bn this year to pay for Kwasi Kwarteng’s plans.
Two-year gilt yields rose 37 basis points (0.37 percentage points) to 4.365% at the start of trading, the highest level since September 2008, when the financial crisis began.
Five-year gilt yields have jumped 32 basis points to 4.38%, the highest level since October 2008, the month Lehman Brothers collapsed.
The yield on the benchmark 10-year Treasury note opened higher at 4.08%, the highest level since April 2010 – up 25 basis points today.
The London-listed blue-chip FTSE 100 opened 0.33% higher, recovering slightly after falling 2% on Friday.
A weaker pound would benefit major exporters, making their goods and services more competitive overseas. Consumer goods maker Reckitt Benckiser (+2.8%), beverage group Diageo (+2%) and pharmaceutical company GSK (+1.7%) were among the gainers.
However, the domestically-focused FTSE 250, a better measure of the UK economy, fell 0.75% to its lowest level since November 2020.
Homebuilders were among the biggest losers in London amid concerns that higher interest rates would hit the housing market.
Sterling has regained some of its earlier losses after a shocking meltdown in Asia-Pacific markets overnight.
Sterling remains in the red against the dollar, down 1.3% today at $1.071, still 1.5 cents below Friday’s close.
Sterling fell 4 cents on Friday as investors feared a surge in borrowing needed to fund Kwarteng’s plans. In early September, the British pound was worth about $1.15.