The pound fell to all-time lows against the US dollar overnight as traders in Asia digested the UK’s “mini-budget” announced by new Chancellor Kwasi Kwarteng on Friday.
Why is sterling suddenly in such terrible shape?
Sterling fell as low as $1.04 before recovering somewhat later in the morning but with dollar parity on the horizon there is now a real sense of panic over the weakness in the UK economy.
Kwarteng’s 2022 growth plan is already dead from the markets’ perspective. The strategy, which promises tax breaks for the wealthy, lavish spending on energy subsidies and social cuts, has drained markets’ confidence in Britain’s ability to weather the country’s economic challenges.
How bad is it?
It is feared that the new government’s policies will push up inflation and public debt, sending the economy into a kind of death spiral with falling living standards and reduced ability to generate growth.
The situation has become so serious so quickly that some commentators are eyeing the arrival of the International Monetary Fund (IMF) on Britain’s shores if new Prime Minister Liz Truss does not change course.
Analysts at Bank of America have called their economic plans “toxic” and warned the British currency is facing an “existential crisis”.
What does this mean for shopping or doing business in the UK?
For buyers, sterling’s weakness has an obvious upside, especially now that it has started to feed into the euro exchange rate in recent days.
As one element of the mini-budget was a VAT-free shopping scheme for goods bought in the UK, some significant bargains are likely to be available, particularly on large ticket items.
But cross-border buyers also have something to gain, despite Northern Ireland’s exemption from the VAT regime. As the euro is relatively worth more, the effective price of goods bought in the north has fallen.
For many companies, however, that’s a different story. Exporters to the UK will incur big losses unless they can raise prices as earnings depreciate in sterling terms.
According to the current trend, goods shipped today earn less if they arrive later in the week – and are worth even less if paid for a month from now.
Did anyone see that coming?
Ironically, former Chancellor Rishi Sunak – who lost the Tory leadership contest to Liz Truss just weeks ago – warned that implementing her policies would result in a loss of confidence in the UK economy. By the end of September, he said, the IMF had to rescue Britain from a self-inflicted economic catastrophe.
The immediate reaction to last week’s mini-budget was less apocalyptic but no more favorable.
To cite an illustrative example, Harvard economist and former Obama adviser Larry Summers told Bloomberg the UK was behaving “like an emerging market that is turning into a declining market” and that the pound would fall below $1.
Indeed, it is difficult to find anyone outside the Tory bubble who has anything good to say about the Truss government’s proposals.
what will happen now
Assuming Truss and Kwarteng don’t immediately reverse course (Kwarteng actually talked about even more tax cuts on Monday), things could actually be grim for the UK economy.
Market prices for gilts – UK government bonds – indicate expectations that interest rates will rise sharply.
That means the Bank of England is likely to be forced into a series of steep rate hikes over the coming months. Some analysts are even forecasting an emergency rate hike to halt the sterling’s decline and provide some stability.
But that would be bad news for UK businesses and consumers, who will now see epic borrowing costs on top of inflation expected to hit 11 per cent.
In essence, Brexit’s slow-motion car crash could take its final tumble.
https://www.independent.ie/business/brexit/what-you-need-to-know-about-collapse-in-sterling-42017408.html What you need to know about the pound sterling collapse