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.
Issuing a punishing verdict on the chancellor’s “dash for growth”, traders sent sterling tumbling on Friday in a broad-based sell-off in response to the huge rise in public borrowing required to finance his plans.
Analysts at the US investment bank JPMorgan said the market reaction demonstrated “a broader loss of investor confidence in the government’s approach”, reflecting the damage to Britain’s standing in global markets.
Citi analysts said the chancellor’s tax giveaway, the biggest since 1972 , “risks a confidence crisis in sterling”.
The pound was down two and a half cents against the dollar to a fresh 37-year low of $1.0993 as fears over the future path for the public finances also triggered a surge in government borrowing costs. The fall below the symbolic $1.10 mark came after the chancellor announced £45bn of tax cuts directed at higher earners.
The FTSE 100 fell more than 2% to trade below 7,000 for the first time since early March, after Russia’s invasion of Ukraine, while the cost of borrowing for the UK government on international markets rose by the most in a single day for more than a decade.
Two-year UK government bond yields – which are inversely related to the value of bonds and rise as they fall – jumped by as much as 0.4 percentage points to come close to 4%, reaching the highest level since the 2008 financial crisis.
Borrowing costs on 10-year bonds rose by more than 0.2 percentage points to trade close to 3.8%, continuing a dramatic climb under way since Liz Truss took over as prime minister earlier this month. At the start of September, yields on benchmark UK sovereign debt have risen by almost one percentage point, significantly more than for comparable advanced economies.
“[It’s] really hard to overstate the degree to which the Kwarteng budget has just wrecked the gilt market,” said Toby Nangle, a former fund manager at Columbia Threadneedle. Illustrating the scale of the turmoil, he said five-year gilt yields had moved by the most in a single day since 1993 - surpassing the Covid pandemic, the 2008 financial crisis, and 9/11.
Investors warned Britain’s experiment with Trussonomics comes at a challenging moment with a soaring US dollar, rising interest rates from global central banks, and with higher borrowing costs across advanced economies amid weaker economic growth and soaring inflation.
However, they said Britain was being singled out after years of the government damaging its reputation for sound economic management, compounded by the steps being taken by the new prime minister.
Gabriele Foa, a portfolio manager at Algebris Investments, said: “We are in a situation in which the UK government has lost a lot of credibility in the past three to four years and pushed the market’s patience in a lot of ways.
“[It’s about] Covid management, government instability, the management of Brexit. It is just a big, let’s say, series of concerns. The UK was in the first league, [but] it’s moving from first, to second to third. If you give some signs that you’re not reliable you move leagues.”
It comes after the Treasury said it would finance the chancellor’s tax cuts and the energy price guarantee for consumers and businesses with £72.4bn in additional UK government debt sales than planned for the current financial year.
Instead of the £161.7bn planned by the Debt Management Office in April, the Treasury said it would now sell £234.1bn of government bonds to international investors in 2022-23.
The change will mean investors are being approached to buy significantly more government debt than previously expected, and comes in addition to the Bank of England preparing to sell £80bn of gilts held on its balance sheet thanks to its quantitative easing programme.
Markets bet the Bank would be forced by Kwarteng’s support schemes to ramp interest rates above 5% by May next year – more than double the current rate of 2.25% – on the expectation they would add significantly to inflationary pressures.
Vivek Paul, a senior portfolio strategist at BlackRock, said: “The credibility of the UK is what markets are reacting to.
“Over time we will know if there will be a fundamental change. The jury is out, [but] the initial reaction from markets is not a ringing endorsement. Let’s put it that way.”
The moves come as the Bank responds to soaring inflation by raising interest rates, despite warning that Britain’s economy is already in recession.
Antoine Bouvet, a senior rates strategist, and Chris Turner, the global head of markets at the Dutch bank ING, said the conditions amounted to a “perfect storm” for the UK as global markets shun sterling and gilts.
“Price action in UK gilts is going from bad to worse. A daunting list of challenges has arisen for sterling-denominated bond investors, and the Treasury’s mini-budget has done little to shore up confidence.”