Probably the events of Friday 23.09.2022 and Monday 26.09 will go down in history. History that is unfortunately not glorious for the UK and the British pound Tonight, the British currency against the U.S. dollar (GBP/USD) was the cheapest on record, falling below the 1.0500 level.
The consequence of UK tax changes against the British pound
Proposals for tax changes in the UK, which are expected to introduce the most significant fiscal stimulus package since 1972, emerged on Friday. As Bloomberg reported, sterling fell as much as 4.7 percent tonight and hit a record low against the dollar, after Kwasi Kwarteng signaled that more tax cuts are coming. Britain's Chancellor of the Exchequer told the BBC on Sunday: "There are more tax cuts on the horizon. I want to see over the next year that people keep more of their income because I believe it is the British people who will drive this economy."
Source: Conotoxia MT5, GBPUSD, MN
Is this why the pound is losing on tax cuts?
First, the UK economy has been hit by high inflation, which the Bank of England believes could remain above 10% for several more months. Second, the Bank of England is planning or already planned to sell bonds on the market to draw down money, thus further tightening monetary policy, in order to fight inflation. Third, cutting taxes reduces revenue to the budget, which could usually be replenished by selling bonds to investors. Fourth, less taxes could mean more money in the pockets of Britons in an era of rampant inflation. In summary, the current measures could lead to a huge supply of debt (the higher the supply, the usually lower the price, the higher the interest rate on bonds), higher costs of servicing it and a harder fight against inflation. This, in turn, could force the Bank of England to make further increases, and these could push the economy into recession. All of this could reflect a loss of foreign investor confidence in the UK government, with politicians working against the Bank of England. As of today, the market is pricing in the possibility of a 150bp interest rate hike in two months, while in a year the main interest rate could rise as high as 6 percent. Now not just to fight inflation, but to encourage investors.
With such action, it is not difficult for the situation to get out of hand and lead to a kind of spiral that is difficult to stop. Nevertheless, the political actions of the British authorities may lead to such a spiral at this point. According to the market, the chances of GBP parity against the USD later this year are growing.
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Daniel Kostecki, Director of the Polish branch of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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