Inflation in the UK (pexels photo)
The rejection received by global investors of the new British government’s plans to reduce taxes caused the value of the pound to drop for a short time to its weakest level against the US dollar until it almost equaled it (1.035). The drop led the central bank to express itself in an attempt to calm the markets.
In the end, statements from the central bank and the government brought little relief to markets, where there are growing expectations that the pound could reach parity with the dollar soon, a thought that was almost unthinkable a few months ago. At the end of Monday, the pound resumed its decline, falling by 1.8% to below $1.07, and also fell by 1% against the euro.
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Andrew Bailey, governor of the Bank of England, said in a statement that the bank was watching markets closely, but suggested that policymakers wait until the next scheduled meeting, on November 3, to fully assess the impact of government policy and the pound’s decline on inflation.
The bank “will not hesitate to change interest rates if necessary to bring inflation back to the 2% target in a sustainable manner in the medium term, in accordance with its role,” the statement said.
But that’s not enough, said Jordan Rochester, a strategist at Nomura, who now predicts the pound will reach parity with the dollar by November. The Bank of England will have to raise interest rates very aggressively, and the British government will have to do something to restore its fiscal credibility, just to slow the devaluation of the pound, he says.
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The parity is also partly due to the strengthening of the dollar, which is hurting currencies all over the world as the Federal Reserve raises interest rates to fight inflation in the United States. The euro fell below parity with the dollar in the summer.
New Prime Minister Liz Truss’ plans have been criticized for going too far in the opposite direction of the central bank’s goals. Bank of England policymakers raised interest rates in an effort to lower inflation, which is near a 40-year high. But the government’s policies could add to longer-term inflationary pressures if people spend the savings on tax and energy bills and the measures don’t sufficiently grow the economy and boost investment. That added to bets that the central bank would have to raise interest rates even more than previously thought.
Analysts at Barclays said they expected the central bank to raise interest rates by three-quarters of a percentage point in November, instead of half a point, after the government surprised investors with “more tax cuts than expected and little promise of how the books will eventually turn out. Calm down.”
The market is facing a greater supply of British government bonds after the Bank of England announced last week a plan to start selling bonds it holds into the market just before the government significantly increased the amount of bonds it planned to sell this year to finance its policy.
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