The currency markets reacted to new U.K. Chancellor Kwasi Kwarteng’s mini-budget on Friday with a rapid sell-off of sterling, leading to a slide in the pound’s value against the dollar and other currencies.
Markets were spooked by the government’s plans to slash taxes by £45 billion without significant spending cuts. That means government borrowing will need to rise to cover state spending — although Prime Minister Liz Truss argues that the jolt to the economy will boost tax receipts.
The 3.6 percent tumble in sterling’s value on Friday was the fifth worst one-day fall in the last four decades. It was topped only by market adjustments to COVID-19, a significant episode in the 2009 financial crisis, Black Wednesday (when the pound was forced out of the European Exchange Rate Mechanism) and the Brexit vote in 2016. And the drop since Truss took office 20 days ago is already larger than that during the entire terms of her immediate predecessors Boris Johnson and Theresa May.
At one point Monday the pound tumbled to its lowest-ever level against the dollar, though it recovered later in the day as markets predicted a sharp interest rate rise from the Bank of England must follow.
The pound’s slide against the dollar and other currencies is already increasing borrowing costs for the government, with 10-year gilt yields shooting up since the tax cuts were announced. At 95.3 percent, the U.K.’s debt-to-GDP ratio looks relatively healthy compared with most others in the G7 group of advanced democracies. But that looks set to worsen as the gap between tax receipts and spending widens.
