Artillery price

Kwarteng deploys ‘full artillery regiment’ against status quo

Fall of the British pound

While the Chancellor’s tax bazooka was greeted by his own benches, the mood in the financial markets quickly deteriorated.

Kwarteng hadn’t even turned up at the shipping box before the pound plunged into the red in the currency markets, nursing a 1pc hit as speculation over tax cuts mounted.

In the hours after Kwarteng’s speech, the losses deepened as concerns over the Chancellor’s borrowing bet grew.

The pound plunged more than 3% against the dollar to hit a new 37-year low below $1.10, the biggest drop since the early days of the pandemic. The erosion of confidence in recent months has triggered a fall of almost 20% against the dollar and a decline of 13% against a basket of currencies this year.

Jane Foley, currency strategist at Rabobank, says the pound has taken a “punch”. But she and the city’s traders fear it could soon plummet to new lows.

“Concerns over the UK’s fiscal situation, combined with its recessionary outlook and extremely high level of inflation, make the pound extremely vulnerable,” Foley said.

Financial contracts suggest there is a 50% chance the pound will now fall to an all-time high against the dollar of $1.05 by the end of the year. The odds of the pound falling to parity with the dollar have risen to one in five this year and 40% over the next 12 months.

Antoine Bouvet, strategist at ING, says the market could even “undervalue the chances of parity”, describing it as a “perfect storm” for the pound and UK bonds.

“A daunting list of challenges faced sterling-denominated bond investors, and the Treasury mini-budget did little to boost confidence.”

Leap bloodbath

The market turmoil has spread to bond markets as investors brace for a flood of debt issues by the UK government.

Interest charges on UK debt have risen to their highest level since 2011, increasing Kwarteng’s cost of borrowing to fund its tax cuts.

The benchmark 10-year gilt yield jumped more than 30 basis points to 3.8% as borrowing costs in the UK rose much faster than other major countries in recent months. The five-year gilt yield rose at its fastest pace on record during yesterday’s rout.

Gilt yields are rising rapidly as Kwarteng embarks on a risky new strategy and markets expect to be hit by the glut of UK government bonds. On top of the additional £62bn of gilts to be sold by the government this year, the Bank of England is increasing pressure on UK bond markets by dumping £40bn of UK sovereign debt it holds over the next 12 months.

Bouvet warns that “the already weakened gilt market is no longer able to accommodate more supply” and Bank of England bond sales.

“The additional borrowing comes at an inopportune time for gilts,” he says.

The stunning moves in the bond markets will have a huge impact on the government’s borrowing costs.

The 0.5 percentage point rise in gilt yields since Thursday morning would add £5bn a year to borrowing alone if sustained, according to the IFS. The huge rise in gilt yields this year could add almost £20bn to the interest cost of debt by 2026/27, according to official figures.

Capital Economics says: “Markets are increasingly concerned about the long-term fiscal outlook.

“Without a major supply-side boost, today’s fiscal package just means more inflation, higher interest rates and a higher debt ratio in the future.”

Exploding prices

One man who will be scratching his head over Friday’s events is Bank of England Governor Andrew Bailey.

The huge package threatens to boost demand just as rate officials try to temper it to bring inflation down. The Bank could be forced into further interest rate hikes not only to combat the inflationary effects of the stimulus jolt, but also to support the pound as its free fall accelerated on Friday.