Bank of England fails to reassure markets after pound plunge
Sep 25, 2022, 11:06 PM | Updated: Sep 27, 2022, 1:12 am
LONDON (AP) — The Bank of England sought to reassure financial markets after the British pound touched an all-time low against the U.S. dollar Monday, but its entreaty fell flat for investors concerned about a sweeping package of tax cuts that further jolted a faltering economy that the government’s plan was meant to prop up.
The central bank said it was “closely monitoring” the markets and would not hesitate to boost interest rates to curb inflation. Its statement came after the pound plunged as low as $1.0373, the lowest since the decimalization of the currency in 1971, on concerns that tax cuts announced Friday by Treasury chief Kwasi Kwarteng would swell government debt and fuel further inflation as the United Kingdom teeters toward recession.
The bank, which raised rates Thursday, said it would fully assess the government’s tax and spending commitments before it meets next in November and “will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term.”
Also Monday, the U.K. Treasury said it would set out a medium-term fiscal plan on Nov. 23, alongside an economic forecast by the independent Office for Budget Responsibility.
The statements did little to ease misgivings about the government’s economic policies, with the pound dropping from $1.0857 to $1.0664 after they were issued. The pound had rallied from the record low earlier in the day on expectations that the central bank might take action to stabilize the currency.
The weakening pound piles pressure on the new Conservative government, which has gambled that it can slash taxes to spur economic growth while at the same time borrowing billions of pounds to help consumers and businesses struggling with soaring energy costs. Many economists say it’s more likely to fuel already high inflation, push down the pound and drive up the cost of U.K. government borrowing — a potential perfect storm of economic headwinds.
Kwarteng has been criticized for failing to release any independent analysis of the plans when he announced the U.K.’s biggest tax cuts in 50 years.
The government plans to cut 45 billion pounds ($49 billion) in taxes at the same time as it spends more than 60 billion pounds to cap energy prices that are driving a cost-of-living crisis.
Kwarteng and Prime Minister Liz Truss, who replaced Boris Johnson as prime minister on Sept. 6, are betting that lower taxes and reduced bureaucracy eventually will generate enough additional tax revenue to cover government spending. Economists suggest it is unlikely the gamble will pay off.
Opposition Labour Party economy spokeswoman Rachel Reeves accused the government of “a return to trickle-down economics, an idea that has been tried, has been tested and has failed.”
“They are not gambling with their money — they are gambling with yours,” she told an audience at the party’s annual conference Monday.
The new and untested Truss also faces pressure from a nervous Conservative Party, which faces an election within two years.
Some Conservatives have welcomed the tax-cutting moves as a return to free-market values after years of state intervention in the economy during the coronavirus pandemic. But others worry it is unconservative for the government to rack up huge debts that taxpayers will eventually have to pay.
Monday’s turbulence follows a 3% fall in the pound Friday, the biggest one-day drop against the U.S. dollar since Johnson announced Britain’s first COVID-19 lockdown on March 18, 2020. Before that, the pound lost more than 10% of its value immediately after the U.K. voted to leave the European Union in June 2016 before rebounding.
The sense of a government losing control led some to compare current events with Sept. 16, 1992 — “Black Wednesday” — when a collapsing pound against the backdrop of high inflation forced the U.K. to crash out of the European Exchange Rate Mechanism, which was meant to stabilize exchange rates. It took the U.K. years to recover from the economic shock.
Kwarteng insisted the government was acting responsibly — and said there were more tax cuts to come.
“We’ve only been here 19 days. I want to see, over the next year, people retain more of their income because I believe that it is the British people that are going to drive this economy,” he told the BBC.
As it is cutting taxes, the government plans to cap electricity and natural gas prices for homes and businesses to help cushion price rises that have been triggered by Russia’s war in Ukraine and have sent inflation to a near 40-year high of 9.9%.
This program will cost 60 billion pounds, and the government will borrow to finance it, Kwarteng said Friday.
He said Sunday that it was the right policy because the government needed to help consumers squeezed by the unprecedented pressures caused by the war in Ukraine and the pandemic.
Britain can afford the cost because its debt as a percentage of gross domestic product is the second lowest among the Group of Seven large industrial economies, Kwarteng said. He said the government would announce a “medium-term fiscal plan” for reducing the nation’s debt in the coming months.
Sterling is not the only currency showing weakness. The euro also hit a fresh 20-year low against the dollar as the war in Ukraine drives fears about recession and energy security ahead of the winter.
While the pound’s slide has accelerated in recent days, the currency has fallen steadily against the dollar for more than a year as investors sought the security of U.S. assets amid the global economic shocks.
The pound’s decline against the dollar also has been fueled by the Bank of England not keeping pace with the U.S. Federal Reserve’s efforts to rein in inflation. Britain’s central bank on Thursday raised interest rates by half a percentage point, compared with large three-quarter-point increase by the Fed last week. But U.K. inflation is the highest among major economies, and the bank predicted that Britain could already be in recession, which it defines as two consecutive quarters of economic contraction.
Many economists say the Bank of England may have to hike rates sooner than its Nov. 3 meeting if the pound keeps sliding.
“There’s been this dramatic loss of confidence in the government’s economic management. But now the ball is in the Bank of England’s court,” said Susannah Streeter, senior investment and markets analyst at financial services firm Hargreaves Lansdown.
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