The British pound fell 2% to $1.1042 on Friday – the weakest currency since early 1985 – as the British government announced historic tax cuts and hefty loan increases.
With the pound already suffering the effects of rampant inflation, the aftermath of the COVID pandemic and Brexit, some traders have also been nervous about the government’s plans.
Why is the pound bad?
Traders appear to be increasingly concerned about the UK’s economic prospects, with runaway inflation triggered by Russia’s war in Ukraine threatening economies around the world.
Rising inflation and a crisis in the cost of living pose an immediate challenge to the government of newly installed British Prime Minister Liz Truss.
Inflation is rising to almost 9.9%, the highest level since the 1980s, and is expected to rise to 11% next month.
The pound fell against the euro – which itself was trading poorly in the currency markets – on Friday morning, falling from €1.14 to €1.13.
Sterling’s decline against both currencies came a day after the Bank of England raised interest rates by 50 basis points. While such a rise would typically drive up currency values, the bottom line is that many other central banks are doing the same.
When the bank raised interest rates, the bank announced that the UK may already be in a recession, defined as two consecutive quarters of contraction. There are concerns that higher interest rates could hold back investment as the cost of borrowing rises.
Meanwhile, some investors are wary of the Truss government’s willingness to fund growth and tax cuts by borrowing.
What is the UK government doing?
Britain’s Chancellor of the Exchequer Kwasi Kwarteng has announced a series of tax cuts to boost growth, saying these would be financed through borrowing and an increase in revenue through increased growth.
Kwarteng said he would cut income taxes, scrap a planned corporate tax hike and lift a cap on banker bonuses in an effort to revive the faltering economy.
The base income tax rate will go down from 20% to 19% next year, while the top rate will go from 45% to 40%.
Kwarteng’s announcements were labeled a “tax event” rather than an actual budget because it was not accompanied by a review from UKTN Office for Budget Responsibility.
The opposition Labor party described the plans as a “desperate gamble”.
“Never before has a government borrowed so much and explained so little… this is not a way to build confidence, this is not a way to build economic growth,” said Labor finance spokeswoman Rachel Reeves.
The UK’s leading economic research body, the Institute for Fiscal Studies, said the tax cut was the largest since the 1972 budget. These cuts are widely believed to have had negative effects by fueling inflation.
rc/wmr (UKTN, dpa, Reuters, UKTN)
British pound sterling plunges to 37-year low as recession looms over Deutsche Welle.