Pound plunges through $1.09 as former US Treasury secretary blasts ‘naive’ UK policies in mini-budget– as it happened

Time to wrap up, after the most turbulent market reaction to a fiscal event that I can remember.

Investors are reeling from Kwasi Kwarteng’s package of huge unfunded tax cuts, and spending pledges such as the energy price freeze.

The pound is languishing at just $1.09 tonight, a 37-year low, and 3.5 cents lighter than yesterday, while UK government bonds have had a shocking day.

The yield, or interest rate, on two-year gilts close to 4% tonight, the highest since 2008, on fears over the huge borrowing ahead.

Here’s are some of our main budget stories:

Politics Live, with my colleagues Andrew Sparrow and Nadeem Badshah, has all the action on a remarkable day.

It’s been a very rough day on the London stock market too.

The blue-chip FTSE 100 has shed 2%, to end the day at a three-month low of 7018 points.

The domestically-focused FTSE 250 index also fell 2%, to its weakest level since November 2020 – when news of successful Covid-19 vaccines triggered a gobal rally.

Recession fears battered European market too, with the German DAX dropping 2%, and France’s CAC down 2.3%.

How bad was today? Bad, very bad….

The situation in the markets is so bad that the Bank of England should hold an emergency meeting to raise interest rates, suggests a Deutsche Bank analyst.

George Saravelos, Deutsche Bank ’s head of global FX research, told clients that a “large, inter-meeting rate hike from the Bank of England as soon as next week” is needed.

This would “regain credibility with the market”, Saravelos explained in a research note.

He added that a strong signal by the BoE that it was willing to do “whatever it takes” to bring inflation down quickly and move real yields into positive territory would help.

Emergency central bank meetings are rare – usually triggered by financial crises, or a pandemic, not a ‘fiscal event’ meant to boost growth.

But Saravelos writes that the BoE needs to take action to prop up sterling.

Both the pound and gilts are experiencing historical drops today.

We are surprised to read some market commentary in recent hours suggesting that the appropriate monetary policy response to this extreme market volatility is for the Bank of England to reverse its planned sale of gilts. In our view, such a policy response would make things worse.

23 Sept 202211.39 EDT

Kalyeena Makortoff

A raft of questions remain unanswered about the government’s £40bn Energy Markets Financing Scheme, our banking correspondent writes.

The programme is meant to make it easier for energy traders to secure bank loans to cover volatile prices, by offering to pay 100% of the losses if those traders go bust. As the Treasury explains:

The scheme will provide short term financial support and will be designed to be used as a last resort, with pricing and conditions reflecting this.

The scheme will ensure that energy firms can continue to operate and manage risk in a cost-effective way in the face of unprecedented volatility. This helps to reduce the eventual cost that businesses and consumers face.

However, the details are slim.

No banks are currently accredited to the scheme, and the details for how to apply or become accredited are still TBC (even though applications open on 17 October.)

We also have no idea:

• how much energy firms will be charged for the loans, either in fees or interest rates,

• how much they will be able to borrow, or

• how quickly they will have to repay the loans.

Like much of the not-so-mini mini-budget, this seems to have been a policy rushed out in haste and the scheme still needs to be designed before banks agree to take part.

But it may be a “lesson learned” moment from the Covid loan schemes, which have been accused of being too lax and being open to fraud. So, instead, the scheme will assemble an advisory committee to assess applicants, making sure they are in “sound financial health”, make a “material contribution” to the energy market, and be willing to undergo solvency checks.

But with the additional support for energy customer bills, it’s unclear what level of financial support is still needed.

And with the added hoops of passing the scrutiny of an advisory committee, it is unclear whether the terms of the loans will be worth the trouble.

Matt Western MP, Labour Member of Parliament for Warwick & Leamington, is also concerned that the markets have lost confidence in the government.

He asked Kwasi Kwarteng today whether he had fired ‘the starting gun on a run on the pound’ – a well-timed question, given sterling’s tumble this afternoon.

In reply, the chancellor accused the opposition of ‘talking down Britain’, and showing ‘an extraordinary interest’ in the gyrations of markets.

The chancellor said that ‘strong growth’ would improve market sentiment – although that market sentiment has clearly soured badly today.

This is turning into an absolute rout on the pound, as the markets give a scathing verdict to Kwasi Kwarteng’s unfunded tax cuts and extra spending.

Having dropped through $1.10 earlier this afternoon, sterling has continued to crash….. all the way down to a new 37-year low of $1.09.

The pound has lost 3.5 cents today, cratering by 3% – on track for its worst day since the market panic of March 2020 when the pandemic hit.

Sterling has also fallen by two eurocents, to €1.1240 (the weakest in over 18 months).

Paul Dales of Capital Economics says the plunge in the pound, and in government bonds, shows that the markets don’t believe the mini-budget will deliver sustained, faster growth.

In a note titled “Kwarteng causes carnage”, Dales says:

The surge in gilt yields and the fall in the pound after the Chancellor announced his hefty tax cuts suggests that the markets have concluded the policies will lead to higher interest rates and more shaky public finances rather than a sustained period of faster real GDP growth. We agree.

While the fiscal loosening may make political sense, the size and timing of it doesn’t make much economic sense.

Investors are losing confidence in the UK government’s approach, warns JP Morgan analyst Allan Monks.

Markets expect [UK interest] rates to rise to over 5% - a reaction that cannot be explained by the mechanical impact of today’s fiscal easing alone, and instead reflects a broader loss of investor confidence in the government’s approach.

Monks has predicted that UK GDP will be 0.4% higher in the near-term as a result of the mini-budget, which he calls “a low return from such a costly and potentially risky package”.

Former Treasury Secretary Lawrence Summers has blasted the economic policies being adopted by Liz Truss, and warned that the pound tumble below parity against the US dollar.

Summers gave a blistering condemnation of the UK government, speaking on Bloomberg Television’s “Wall Street Week” with David Westin.

“It makes me very sorry to say, but I think the UK is behaving a bit like an emerging market turning itself into a submerging market.

“Between Brexit, how far the Bank of England got behind the curve and now these fiscal policies, I think Britain will be remembered for having pursuing the worst macroeconomic policies of any major country in a long time.”

Summers, who was Secretary of the US Treasury from 1999 to 2001, said he wouldn’t be surprised if the pound eventually gets below a dollar, if the current path is maintained.

He added:

This is simply not a moment for the kind of naïve, wishful thinking, supply-side economics that is being pursued in Britain.”

Liz Truss is choosing a markedly riskier path in a bid to revive growth, says George Lagarias, chief economist at Mazars.

Echoing the 1980s, the ‘Great British Pivot’ includes a mix of tax cuts, consumption and business boosting, de-regulation, union weakening and unemployment disincentives.

Whether it will succeed remains to be seen and the danger lies not in the course taken, but in the difficulty of implementation.

There are several factors that must be overcome for growth to take hold, he explains:

• The markets might not give Mr Kwarteng the time necessary for his plan to succeed. Traders, most of whom have never experienced such radical fiscal action in the UK, already reacted negatively. Two hours after the announcement, the Pound was losing 3% to the Dollar.
  

• Inflation could grow as the Pound loses ground. This could wipe out consumer savings from taxes.
  

• The Bank of England may decide to hike interest rates faster, to defend the Pound and stop imported inflation. Higher interest rates would mean that savings from taxes would end up being paid in higher mortgages.
  

• Global growth could continue to drop, affecting the demand for British exports and the prices for British imports.
  

• The de-regulation announced, as well as plans to prop up the British financial sector, could be hamstrung as Brexit negotiations which may determine access to European markets have yet to take place.”

Economics professor Danny Blanchflower, former policymaker at the Bank of England, has condemned today’s mini-budget as the ‘economics of the madhouse’

Blanchflower fears the housing market is going to crash, as interest rates are hiked (possibly to 5% by next summer).

23 Sept 202210.17 EDT

Pound has now fallen below $1.10

Angela Monaghan

The pound has fallen below $1.10 for the first time since 1985 as investors took fright at the prospect of a surge in government borrowing to pay for Kwasi Kwarteng’s sweeping tax cuts.

Sterling was down by more than two cents against the dollar to a fresh 37 year low as fears over the future path for the public finances also triggered a surge in government borrowing costs.

The FTSE 100 was down more than 2% at 6,989 while the FTSE 250, which includes more domestic-focused firms, also fell more than 2%.

The sharp sell-off followed a raft of tax cutting measures announced by the chancellor, in the biggest giveaway in 50 years. Measures included the scrapping of the top 45% rate of income tax, which currently applies to those earning more than £150,000 a year.

The plunge in the pound today means that poorest households are actually worse off, calculates Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

That’s because they only get a few crumbs from the mini-budget (while high earners get a generous tax cut), while the fall in sterling will push up imported goods prices.

The money markets are now anticipating that UK interest rate could soar over 5% by next summer, due to the impact of the government’s tax cuts.

That’s more than twice their current level, even after the Bank of England’s half-point increase on Thursday, to 2.25%.

It would drive up the cost of variable mortgages sharply, and other forms of credit, hitting borrowers badly.

ING explain:

Bond holders are already rattled by inflation and by the prospect of more Bank of England (BoE) hikes. Even if the central bank hiked only 50bp yesterday, compared to market pricing of 75bp, markets are betting that the pace of hikes will have to accelerate.

The recent jump in yields implies that Bank Rate will peak next year well above 5%.

That in itself is not a great backdrop for bonds but what has rattled investors is the prospect of the BoE hiking more in response to generous fiscal policy.

Anxiety about the cost of freezing energy bills is also hitting UK gilts (government debt).

Investors are worried the UK Treasury may have signed a blank cheque, because the cost of the guarantee depends how high gas and electricity prices remain.

ING’s Senior Rates Strategist Antoine Bouvet and Global Head of Markets Chris Turner, explain

Alongside the confirmation of additional borrowing this year, the raft of tax cuts unveiled today clearly implies that it will not be contained to just this fiscal year.

The cost of the newly-announced measures is reported to be £160bn over five years but, with the cost of the energy price guarantee highly dependent on wholesale energy prices, investors are worried the Treasury has effectively committed to open-ended borrowing.

For all Kwasi Kwarteng’s talk about getting growth up to 2.5%, the mini-budget may only deliver higher interest rates, and a higher national debt in the long term.

So warns Ruth Gregory of Capital Economics:

The Chancellor claimed that this was a plan for growth. But unless the Chancellor’s gamble pays off and the government’s fiscal policy boosts GDP growth by 0.5-1.0ppts per annum, the risk is that once the near-term boost to GDP fades, the legacy of the government’s fiscal plans will be higher interest rates and a higher public debt burden.

The market reaction, which included a jump in gilt yields, means higher borrowing costs are already here.

The cost of insuring Britain’s debt against a default has risen to its highest level since mid-2020 as concerns mounted about the government’s plans to slash taxes and ramp up spending, Reuters reports.

Here’s the details:

S&P global market intelligence data showed 5-year credit default swaps (CDS) - derivative instruments that debt investors typically use to hedge risk or bet against something - jumped 3.5 basis points to 34.5 points.

Such a large move is unusual for a G7 economy and it took the CDS level to its highest since mid-2020, when global markets were still in the most volatile stage of the Covid-19 crisis.

Cost of insuring UK government debt against default jumps

As the UK issues its own currency, it can’t ever be forced to default on its debt, though.

The bond market is ‘completely spooked’ by Kwasi Kwarteng’s mini-budget.

So warns Toby Nangle, former global head of asset allocation at Columbia Threadneedle.

He has shown how today’s surge in five-year gilt yields (as bond prices have slumped) is worse than in any crisis since 1993.

Pound parity suddenly looks more likely following the mini-budget, says Fiona Cincotta, Senior Financial Markets Analyst at City Index.

Far from soothing concerns over the outlook for the UK economy, Liz Truss and Kwasi Kwarteng’s economic plan for the UK has sent the pound plunging. The announcement of the largest tax cuts since 1972 to boost growth and stave off a recession that has already started, has triggered a crash in the pound and the bond market.

The selloff in UK assets reflects the sheer panic as the new government’s stimulus package will not only grow an already sizeable debt burden, potentially to unmanageable levels but will also add to inflationary pressures.

The BoE, which has been reluctant to hike rates aggressively, will need to roll up its sleeves and fight inflation with larger rate hikes for here. Expectations for a 1% hike in November are already climbing.

It’s difficult to see how the pound can recover from here. Investors are pulling out of UK assets rapidly and who can blame them? Drawing comparisons historically, the last big tax giveaway in 1972 resulted in rampant inflation, unmanageable debt, and an IMF bailout.

Suddenly pound parity with the USD doesn’t look so unlikely.