Pound tumbles on inflation surge and US debt crisis

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The pound fell to an eight-month low against the dollar on Tuesday and Britain’s cost of borrowing soared as investors turned away from the country following a rolling series of crises and sharp rises in inflation.

Sterling tumbled 1.3pc to just under $1.3530 amid growing concerns over a fuel shortage triggered by the panic buying of petrol.

The fall takes sterling to its lowest level since January, undoing a reappraisal of the currency in the wake of by Britain’s world-leading vaccine rollout. It also dropped 1.2pc against the euro.

Jitters over supply chain turmoil sent borrowing costs on a ten-year Government bond above 1pc for the first time since March 2020.

It came amid a wider market sell-off as traders confronted the prospect of higher global inflation and a rise in interest rates. The S&P 500 dropped 1.7pc in New York, while markets in Paris, Milan and Frankfurt all closed more than 2pc in the red. The FTSE 100 closed just 0.5pc lower, because many of its member companies earn their money in foreign currency which is worth more if sterling is weak.

Central bankers around the world are growing increasingly nervous over the prospect of runaway prices after the Federal Reserve’s recent signal that it was ready to slow its $120bn (£89bn) a month money-printing programme from November.

On Monday the Bank of England Governor, Andrew Bailey, also warned that rate-setters were ready to “step in” if inflation lurched out of control.

Money markets predict the Bank will raise rates from their record low of 0.1pc to 0.25pc in February, followed by a further rise to 0.5pc in August, as Threadneedle Street expects inflation to linger above 4pc until at least April.

Jordan Rochester, a currency analyst at Nomura, said: “Rising inflation concerns are making sterling-denominated assets less attractive.”

Brent crude oil further fuelled inflation fears, briefly jumping above $80 per barrel for the first time in almost three years on concerns over surging demand and tight supplies as the world emerges from the Covid crisis.

Investors are also nervous because the US is also on the brink of hitting a $28.4 trillion cap on borrowing, raising the prospect of a Government shutdown unless a bipartisan deal is reached. Jamie Dimon, the boss of JP Morgan, said that the Wall Street bank is preparing for the risk that America will default as a result.

Britain’s rising borrowing costs come as the nation still relies on bond markets to fund the financial aftermath of the pandemic. In March, the Office for Budget Responsibility (OBR) predicted borrowing of £234bn this financial year.

The OBR has also warned that a 1 percentage point rise in interest rates and inflation could add £25bn to the UK’s debt interest bill by 2025.

The Bank has insisted that the spike in prices will be “transitory”. But the so-called break-even rate – the difference in price demanded by investors to buy inflation-linked debt and conventional bonds, taken as a gauge of future inflation expectations – is closing in on 4pc, a level not seen since 2008.

The rise in Government borrowing costs was part of an international bond sell-off. The cost of US 10-year debt also hit post-pandemic highs above 1.5pc.

David Page, head of macroeconomic research at AXA Investment Managers, said the price moves reflected “market rewiring” following Mr Bailey’s speech.

He said: “The theme is a continued expression of concern from the Bank about supply pressures, and the obvious risk that we are seeing a more persistent pressure on inflation.”

The inflation fears come despite labour market uncertainty ahead. More than 1.5m workers leave the furlough scheme at the end of the month. and the weakening economic recovery has now entered the “hard yards” according to Mr Bailey.