Traders bet on emergency interest rate rise after pound hits record low

The pound tumbled to a record low on Monday while government bonds extended heavy losses, stirring expectations of a Bank of England statement or an emergency rise in UK interest rates after chancellor Kwasi Kwarteng’s package of tax cuts last week.

The currency lost as much as 4.7 per cent to trade as low as $1.035 against the dollar early in the morning after Kwarteng vowed at the weekend to stick with his tax-cutting drive, prompting warnings that the UK is entering a currency crisis.

Neither the BoE nor the Treasury denied rumours there would be a BoE statement later on Monday in the wake of the currency’s slide. The central bank declined to comment on whether it was planning an emergency interest rate meeting this week. The pound later clawed back losses to trade just below $1.09.

The early fall took the pound to its lowest level ever recorded. It followed steep falls on Friday, when the chancellor announced a massive new wave of borrowing to fund £45bn of tax cuts and a package to curb rising energy bills.

“The UK is now in the midst of a currency crisis,” said Vasileios Gkionakis, Citigroup’s Emea head of foreign exchange strategy.

Traders ramped up bets on an emergency interest rate rise to stabilise sterling before the Bank of England’s next meeting in November. Derivatives markets are pricing in a rise of 0.75 percentage points in a week’s time and an increase of more than 1.5 percentage points by the November meeting. Rates are expected to top 6 per cent by May, up from the current level of 2.25 per cent.

Reflecting the large shift in interest rate expectations, UK government debt dropped further on Monday following Friday’s bruising sell-off, the worst day for the gilt market since the early 1990s.

The 10-year gilt dropped in price, pushing yields up by a sizeable 0.23 percentage points to 4.06 per cent, up from about 3.5 per cent before Friday’s fiscal announcement.

Underpinning the pressures on sterling, the OECD downgraded its forecasts for the UK on Monday. According to its latest projections, based on research carried out before the tax cuts announcement, the British economy will grow by 3.4 per cent this year and not at all in 2023.

The Treasury did not comment on Monday on the market movements. Kwarteng told the Financial Times in an interview last week: “Markets move all the time. It’s very important to keep calm and focus on the longer-term strategy.”

But Mel Stride, Tory chair of the Treasury select committee, criticised the chancellor for signalling more tax cuts.

“It would be wise to take stock of how through time the markets weigh up recent economic announcements rather than immediately signalling more of the same in the near term,” he said.

Gerard Lyons, who has been advising prime minister Liz Truss’s new team on economic policy, said Kwarteng needed to do more to explain his approach to the markets.

“He needs to reaffirm that tax cuts are only part of the story, not the full story,” Lyons said in a Bloomberg Radio interview. “What they’re following is a supply-side agenda.”

The BoE’s rate-setting Monetary Policy Committee has previously met outside the normal cycle when markets have been turbulent in a bid to restore calm, typically by cutting rates. Since it gained independence in 1997, the BoE has never raised rates between scheduled meetings.

Sushil Wadhwani, an asset manager and former BoE policymaker, said: “If I were still at the BoE, I would be tempted to announce an extra meeting in a week.”

Westminster’s tax cuts come as the UK is already expected to spend £150bn to subsidise energy costs for consumers and businesses. A large portion of this borrowing is to be financed by gilts.

Unlike big tax cuts in the 1980s, Kwarteng is borrowing tens of billions of pounds to fund his plans, adding to demand at a time the BoE is raising rates to bring inflation under control.

“It looks like we’re headed for a spiral that we usually see in emerging markets crises, where policymakers struggle to reassert credibility,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore. He highlighted that the country was still running a “gaping current account deficit”.

“If we continue to see these huge moves in the market, the Bank of England will have to raise interest rates, perhaps as much as 1 percentage point, to try and stabilise the pound,” he added.

The Bank of England raised interest rates by 0.5 percentage points on Thursday, after a third successive 0.75 percentage point rate increase by the US Federal Reserve a day earlier.

But some investors say an unscheduled rate increase could be counterproductive.

“An emergency hike to counteract the damage of an emergency mini-budget is not a good look and would probably be taken badly by markets,” said Jim Leaviss, head of public fixed income at M&G Investments. “People say you know you’re an emerging market if you hike rates and the currency depreciates even further. The BoE probably doesn’t want to test that theory out.”

Rachel Reeves, Labour’s shadow chancellor, said higher interest rates were increasing the cost of living for households.

“The prime minister and chancellor are like two gamblers in a casino chasing a losing run . . . they are not gambling their money, they are gambling all of our money,” she told the BBC Radio 4’s Today Programme.

Labour has promised to reverse some of the government’s tax cuts — on National Insurance, corporation tax and the scrapping of the 45p rate — but would keep the looming cut in basic income tax from 20p to 19p. 

Tommy Stubbington and Chris Giles in London, George Parker and Jim Pickard in Liverpool, and Stephanie Findlay and Hudson Lockett in Hong Kong. Additional reporting by Adam Samson in New York and Leo Lewis in Tokyo

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