The British pound fell to an all-time low against the U.S. dollar on Monday following the government's announcement of planned tax cuts and investment stimulus to spur growth.
In what proved to be an extremely volatile trading session, GBP/USD hit a new record low of 1.0382 before closing the day at nearly 1.07. The combination of the continued dollar strength amid rapidly rising bond yields in the U.S. and the pound's weakness has now pushed the pair towards parity.
The market has interpreted recently-announced tax cuts and investment incentives as friendly to high-wealth individuals, which could lead to the U.K. taking on substantial debt amid a period of high-interest rates.
Mazen Issa, senior forex strategist at T.D. Securities, said:
″[It] doesn't seem like the U.K. government is throwing the market a bone here in terms of having a much more tempered fiscal trajectory, and so I think at this point right now, the path of least resistance is going to remain lower (...) Below $1.05, you really look at parity."
Issa believes the sterling could end up like the euro and even drop below the dollar in the future. Several Forex analysts cut their price targets on GBP/USD yesterday, with some calling for parity before the year-end.
What Is Driving The Pound Lower?
The pound's weakness is a result of three key factors:
- Aggressive rate hikes by the Fed
- BoE's 50 basis points rate hikes
- Big tax cuts announced
On Friday, the U.K. announced the highest tax cuts in 50 years, which resulted in predictions that the government would have to issue more bonds and take a substantial debt to pay for the cuts. Further, U.K. Finance Minister Kwasi Kwarteng said further tax cuts could come in the following months.
After hitting a 20-year high recently, the U.S. dollar took a breather Tuesday as investors tested their confidence in risk assets. Equities also received an additional boost after the U.S. treasury yields' gains slowed down. Still, most investors have abandoned risk-on assets and remain heavy in cash and passive income.
Some investors reduced their dollar positions recently. However, the gains in other currencies were almost insignificant compared to how much the dollar rose in the past few months.
The euro still hoveres around its 20-year low, while the yen is just above its 24-year bottom the last week before Japan stepped in to shore up its battered currency. The yen has been significantly hurt recently after Japan's central bank said it plans to maintain its dovish monetary policy amid rampant inflation.
Andrew Bailey, Governor of the Bank of England, said Monday that the bank "will not hesitate" to hike interest rates to bring inflation to the desired 2% target and that it continues to keep a close eye on the markets. The Governor said in a statement:
"The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets."
However, even this "verbal intervention failed to provide much support to the embattled pound. That is because investors believe these BoE remarks have reduced the likelihood of another rate hike before the scheduled rate announcement on November 3.
The Bank of England hiked interest rates from 1.75% to 2.25% last week, with some expecting another emergency rate increase. The market is now pricing a 75 bps rate hike by BoE in November, providing some support to the pound.
Prior to Bailey's statement, finance minister Kwarteng said he plans to unveil a medium-term fiscal plan on November 23, with the Office for Budget Responsibility expected to release updated growth and borrowing forecasts.
Capital Economics economist Paul Dales slammed the U.K. government and the BoE, saying the authorities have done "the bare minimum" to support the slipping pound and government bond prices.
While this could be enough to "stop the rot," the markets will likely need additional reassurance and some actual intervention in the future, such as "details on the fiscal rules, a change in policy from the government and/or an interest rate hike from the Bank at an emergency meeting," he added.
Summary
The GBP/USD price hit a fresh record low after yesterday's plunge pushed the pair below the 1985 low. The combination of tax cuts, a "dovish hike" by BoE, and aggressive Fed tightening has created intense selling pressure among U.K. forex brokers on the GBP, which likely won't stop anytime soon.