The pound’s plummeting value has pushed the interest rate on government debt to a 12-year high, with money markets now predicting the Bank of England’s base rate could nearly triple to 6% next year.
The pound fell to an all-time low of $1.03 against the dollar overnight before recovering to $1.07 in morning trade as traders priced in expectations of a major Threadneedle Street intervention to support the currency.
Traders expect the central bank to convene a meeting of its Monetary Policy Committee (MPC) soon to raise interest rates from 2.25% to 3% before raising them further at a scheduled meeting. in November.
One analyst described the situation as ‘toxic’, while another said investors had digested the implications of Friday’s mini budget, which added another £45bn of unfunded tax cuts on top of that. an estimated £150billion bill for its energy price bailout, and ‘seemed inclined to view Britain’s Conservative Party as a doomsday cult’.
Another rout of the British currency could send it below parity with the dollar and into uncharted territory on international exchanges.
It is understood that the MPC, chaired by Bank Governor Andrew Bailey, will be reluctant to step in when defending the currency is not among its responsibilities, instead focusing on its goal of bringing inflation down to 2% in the future. over the next two to three years. years, compared to 9.9% in August.
However, several MPC members stressed the fact that a fall in the value of the pound can fuel inflation via the increase in the cost of imported goods and raw materials.
A rise in interest rates, if it supports the value of the pound, could limit the pressure on inflation, although traders could interpret an emergency rise as a panic signal to the Bank, prompting further new sales.
Adding to concerns about the government’s grip on economic policy, the cost of financing UK debt has doubled in international bond markets. The interest rate on five-year government bonds rose to 4.5% from 2% last month and just 0.5% a year ago.
Analysts at Bank of America Merrill Lynch said the “trickle down economy” theory behind the mini-budget was flawed. “Empirical evidence suggests that tax cuts of this type have an inconclusive effect on potential growth.” They said the cost amounted to 1.5% of GDP but would only boost growth by 0.2%.
In response to Tory MPs’ concern over the financial market reaction, analysts added: “The political backdrop is toxic and pushing [the pound] towards an existential crisis.
Samuel Tombs, chief UK economist at consultancy Pantheon Macroeconomics, said markets were pricing in a 0.75 percentage point hike in the central bank’s base rate before the end of the week.
The pound recouped the weekend’s losses after traders speculated that the MPC would intervene, he said. “Sterling will weaken further if Governor Bailey does not act,” he said.
Paul Dales, chief UK economist at Capital Economics, said Bailey could come out with a “tough talk” backed by a large and immediate rise in interest rates. “It could imply something like a [one or 1.5 percentage point] interest rate hike (to 3.25% or 3.75%), possibly as early as this morning,” Dales said.
Shadow Chancellor Rachel Reeves told Times Radio she was “incredibly worried” about the market’s reaction to the mini budget.
Former MPC member Martin Weale said markets were “frightened” by the unfunded tax cuts injected into the economy at a time of high inflation. “It is difficult to see this policy [of tax cuts] ending happily.
Weale added: “I expect the pound to continue to fall this week, and if it does the Bank of England may have to step in with even higher interest rates.”
The Kings College London economics professor played down fears of an emergency MPC meeting but warned his base interest rates could head towards 4% or 5%, pushing mortgage rates to the above 7%.
Nick Macpherson, former Permanent Secretary to the Treasury, has expressed concern that his successor, Tom Scholar, a veteran of the 2008 financial crash, was sacked by Chancellor Kwasi Kwarteng ahead of the mini budget.
“Sacking your only official with serious crisis management experience, then precipitating a crisis a fortnight later, takes postmodernism to a new level,” he said.