LONDON – The British pound hit a record low against the US dollar on Monday after the new government’s decision to enact major tax cuts to boost growth, adding to fears of a global recession.
The fall in the pound comes as Britain faces rising public debt and a cost-of-living crisis, amid deteriorating investor confidence. He also raised the possibility that the Bank of England could intervene in the currency markets to strengthen the pound.
The fall in sterling partly reflects the strength of the US dollar, which has been boosted by higher interest rates. But it has also fallen against many other currencies, indicating specific concerns about the British economy.
Who is Liz Truss, the new Prime Minister of the United Kingdom?
The pound hit a record low of $1.03 in early Asian trading on Monday, before recovering some ground to settle around $1.08, still well below where it was on Friday in the morning before the government presented its “mini-budget”.
The drop comes as global markets falter and fears of a recession grow in many geographies. In the United States, the Federal Reserve raised interest rates last week in its ongoing push to control high inflation. It was the fifth rate hike of the year and the third consecutive increase of three quarters of a percentage point. That hit Wall Street, and on Friday the Dow Jones industrial average had closed below 30,000, to its lowest point since 2020.
“We have to put inflation behind us,” Federal Reserve Chairman Jerome H. Powell said last week. “I wish there was a painless way to do it. There isn’t.”
Major US indexes were mixed Monday morning, with the Dow down about 125 points, or 0.4 percent, and the S&P 500 down 0.2 percent. The tech-heavy Nasdaq rose 0.3 percent.
The fall in the pound comes about two months after the euro reached parity with the dollar for the first time in nearly two decades. The war in Ukraine has disrupted food supplies and driven up energy costs around the world, especially in Europe. This, combined with the Fed’s rising interest rates, has made the dollar a relatively safer bet for investors.
A weaker currency, of course, does not necessarily reflect a weak economy. In many cases it may be advantageous, for example, to make British exports cheaper for American consumers; therefore, a weak pound will increase overseas sales for export-oriented companies. But it does mean that anything denominated in dollars, such as energy costs, will go up for consumers.
That’s good news for American tourists in the UK, who are suddenly finding their dollars go much further. It’s not good news for many British households, who are already facing rising energy bills and 10% inflation. They will find the costs of imported goods and services rising, from fuel for vehicles to food on plates: in 2020, the UK imported 46 per cent of the food it consumed.
On Friday, Kwasi Kwarteng, the new Chancellor of the Exchequer, or finance minister, announced a package of tax cuts worth 45 billion pounds ($48 billion), the biggest shake-up of his tax system in 50 years. The top rate for income tax was cut from 45 percent, the cap on bank allowances will be removed and taxes on house purchases were cut, moves that will mainly help the wealthiest citizens in the hope that they will increase their spending.
Although the new prime minister, Liz Truss, had promised to cut taxes during her leadership campaign, the scale of the cuts still surprised many economic observers.
“In today’s economic environment it’s a huge gamble,” wrote Thomas Pope, an economist at the Institute for Government. It is a major shift from the policies of Truss’s predecessor, Boris Johnson, who last year announced tax increases to help pay for fighting the pandemic.
Britain’s new government hopes that by cutting taxes and regulations, it can generate growth that will help fund public services and eventually pay down the debt.
John Hardy, head of currency strategy at Saxo Bank, said the pound was falling because the government’s maths is not reassuring to investors.
“It’s a numbers game and their numbers don’t add up,” he said.
Investors are looking at where inflation and the UK balance sheet are headed.
“They’re saying, ‘I don’t want to own the UK newspaper because they don’t play responsibly.'”
Truss, who is only three weeks into his new job, has defended the tax cut bonanza.
In a recent interview, CNN’s Jake Tapper told Truss that Britain’s opposition parties are arguing that his plans are “recklessly piling up the deficit” and that President Biden is “essentially saying that the your approach doesn’t work.”
Last week, Biden tweeted: “I’m sick and tired of the trickle down economy. It’s never worked.” He was referring to supply-side economics made famous by President Ronald Reagan, which Truss’s approach resembles.
In the interview, Truss replied: “The UK has one of the lowest levels of debt in the G-7. But we have one of the highest levels of tax. We currently have a 70-year high in our tax rates . And what I’m determined to do as Prime Minister, and what the Chancellor is determined to do, is make sure we’re incentivizing businesses to invest. And we’re also helping ordinary people with their taxes.”
Truss continued: “That’s why I don’t think it’s right to have higher national insurance and higher corporation tax, because that will make it harder for us to attract the investment we need to the UK. It will make it harder to generate those new jobs of work.”
Rachel Lerman contributed to this report.