Sterling Slumps to Record Low; Kwarteng Points to More Tax Cuts

By Peter Nurse

Investing.com - The British pound continued to slump in early European trading Monday, falling to a record low against the soaring U.S. dollar as traders doubted the sustainability of the new U.K. government's economic plan.

GBP/USD slumped as much as 5% to an all-time low of 1.0327 earlier Monday, before stabilizing around 1.0714, 1.7% below the previous session's close.

This weakness followed hefty selling on Friday after new U.K. finance minister Kwasi Kwarteng unveiled the country’s biggest package of tax cuts in 50 years, which would likely have to be funded by the biggest increase in borrowing since 1972 even with the country facing slowing growth and twin deficits.

Kwarteng added in an interview on Sunday that he wants to keep cutting taxes as part of an effort to boost U.K. economic growth, telling the BBC there was "more to come".

“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,” said analysts at ING, in a note. “Widening rate differentials are no consolation for the pound, with FX remaining the main vehicle to price U.K. country risk.”

Further losses for the pound look likely. 

"With broad unfunded spending on the fiscal side unmatched by monetary policy to offset the inflationary impulse, the currency is likely to weaken further," said analysts at Goldman Sachs, in a note. "We are revising our GBP forecasts weaker vs EUR to 0.92, 0.90, 0.88 in 3, 6, and 12 months (vs 0.85, 0.83, and 0.84 previously). We are also downgrading our GBP/USD forecasts for 3, 6, and 12 months ahead to 1.05, 1.08, and 1.19."

Traders are now pricing in a more robust response from the Bank of England after its hike of just 50 basis points last week, with the market now pricing in interest rate increases of at least another 135 basis points by November.

Still, it's debatable how much this will do to support the beleaguered currency.

“The short pound is not only market’s favorite trade for a stagflation proxy but the pound is also facing a confidence issue,” said Christopher Wong, a currency strategist at Oversea-Chinese Banking Corp. in Singapore. “We remain cautious on a potential downgrade to the UK’s sovereign rating or outlook.”  

Sterling’s weakness helped the safe-haven U.S. dollar climb to a new two-decade peak against a basket of major peers. 

At 03:05 ET (07:05 GMT), the US Dollar Index, which tracks the greenback against a basket of six other currencies, gained 0.4% to 113.430.

The euro was also hard hit, with EUR/USD trading 0.6% lower to 0.9632, after earlier falling to a fresh 20-year low below 0.96.

The escalation in the Ukraine war, with Russia holding widely-criticized votes aimed at annexing territory it has taken by force, has hit the single currency, along with the uncertainty surrounding the weekend election in Italy which is set to propel a right-wing alliance to power in the Eurozone’s third-largest economy.

USD/JPY rose 0.4% to 143.86, with the yen slipping despite last week’s intervention by Japanese authorities to support the yen for the first time since 1998.

Data showed that Japanese business activity grew slightly in September, but the outlook for the Japanese economy remained pressured by high inflation and a weakening yen.

The risk-sensitive AUD/USD fell 0.6% to 0.6491, and USD/CNY rose 0.5% to 7.1620, with the yuan hitting a fresh two-year low against the dollar despite several measures by the People’s Bank of China to curb further losses in the currency.