Why a plunging pound bad news for UK?
The pound hit a record low against the dollar this week, falling near $1.03 before recovering to near $1.07.
When a currency loses value, it can be helpful to manufacturers, making their export cheaper.
But given the broader economic context, few would view the precipitous decline as a positive development.
A major concern is what it means for paying for imports.
The cost of energy is a particular concern when the weather turns cold.
As raw materials are usually paid for in dollars, a rising greenback and a falling pound will mean higher prices for UK importers.
And while countries in Europe are scrambling to store natural gas to reduce their reliance on Russia, the UK lacks similar storage capacity, making it even more vulnerable to the current market price.
Moreover, added to this is the rapid increase in the cost of credit for the State, companies, and households.
Investors expect the Bank of England to raise interest rates much more aggressively to contain inflation.
They now expect rates to rise to around 6% by next spring. Interest rates have not been that high since 2000.
As the central bank only started raising rates in December, when interest rates hit 0.1%, the rapid turnaround could cause a major hit.
“The sharp rise in interest rate expectations has already added £ 1,000 per year to the upcoming mortgage hike for a typical borrower, while the drop in the pound means that more expensive imports are driving higher inflation,” stated Bell.
As a result, people living in the UK would see a drop in living standards, she added.
Halifax, owned by Lloyds Bank (LLDTF), removed some of its mortgage products, while Virgin Money did not accept mortgage applications from new customers until “this week” due to wild market moves.
The UK government’s decision to implement the biggest tax cuts in 50 years and borrow tens of billions of dollars this winter to subsidize rising energy costs is a huge gamble that has shocked the markets financially.
Since Friday, when Finance Minister Kwasi Kwarteng formally announced the plans, the British pound has fallen 5% against the US dollar, bringing this year’s total loss to a dazzling 21%.
By comparison, the euro fell around 15% against the dollar over the same period.
The riots don’t stop there. Investors were quick to ditch UK government bonds as they are concerned about the additional £ 72 billion ($ 77 billion) of loans maturing before April.
The 5-year debt yield, which moves on opposite prices, has increased from around 3.6% to over 4.4% in the past two trading sessions, an astronomical leap into a corner of the financial universe that sees typically movements in small fractions of one percent.
The Bank of England said in an emergency statement that “it is monitoring developments in the financial markets very closely,” while the UK Treasury Department said plans to ensure the sustainability of public finances will be published by the end of January.
But that may not end the chaos, the effects of which will not be limited to the markets.
A falling pound is a bad news for an economy that may already be in a recession as it becomes more expensive to import essential goods such as food and fuel.
This could fuel decade-long inflation that is causing a cost-of-living crisis for millions of families.
As a result, the Bank of England will be under pressure to raise interest rates further and faster.
This would increase the cost of borrowing for businesses and individuals, leaving less money for businesses to invest and for consumers to spend.
A more fundamental question could continue to fuel volatility.
As the Truss government seeks to boost demand to mitigate a recession this winter, the Bank of England is trying to cool the economy to avoid the fastest rising prices among G7 countries.
This tension will reduce confidence in the way forward.
