Sterling continues to slide after Friday’s mini-Budget

The pound has continued to fall hard and is heading towards parity with the US dollar. Saloni Sardana explains why, and what it means for the UK, for markets and for you.

Sterling continued its slide on Monday, falling to its lowest since 1971 as the currency was still reeling from the aftermath of Friday’s mini-Budget, raising the odds of an emergency interest rate rise. 

Sterling fell as low as $1.0384 in the early hours of Monday, though it recovered to trade around $1.0705 later in the day. The pound also fell hard against the euro to €1.082, the lowest level since September 2020. 

In Friday’s mini-Budget UK chancellor Kwasi announced a government growth plan that included new and previously announced measures. These included an Energy Price Guarantee, removal of the higher rate of income tax and a number of other tax cuts. 

The mini-Budget sparked heavy selling in gilts and sterling as the chancellor scrapped the higher rate of income tax.

A separate announcement from the UK Debt Management Office last week said it is raising the amount of gilts it plans to sell by £62.4bn, taking the total planned sales to £193.9bn in 2022-2023. 

Markets are betting on an emergency interest rate rise 

According to the Financial Times, the sharp depreciation in sterling has raised the odds of an emergency interest rate rise. 

“Traders ramped up bets on an emergency interest rate rise before the Bank of England’s next meeting in November. Derivatives markets are pricing in a rise of more than 0.5 percentage points in a week’s time and an increase of nearly 1.5 percentage points by the November meeting,” says the FT. 

It comes despite the Bank of England raising interest rates by 0.5 percentage points earlier this month to the highest level since 2008, taking the base rate to 2.25%. 

The chancellor’s mini-Budget was not well received by gilts. UK bonds sold off further on Monday, with ten-year yields climbing above 4% for the first time since 2010. For context, it was around 0.4% one year ago. 

This means holders of UK gilts are likely to want a higher return to hold these bonds, meaning further interest rate rises are inevitable. 

“The reaction in the bond market to the misnamed mini-Budget (it was anything but mini) is striking with yields surging after the chancellor unveiled sweeping tax cuts that abandon any semblance of fiscal discipline,” says Neil Wilson, chief market analyst at Markets.com 

“It means more borrowing and more borrowing costs. This is not the reaction any chancellor wants from a budget, but what else could he expect?”

Much of the UK’s tax cuts are expected to be funded from selling gilts, putting the UK in an unfavourable fiscal position. 

"The cost of the newly-announced measures is reported to be £160bn over five years but, with the cost of the energy price guarantee highly dependent on wholesale energy prices, investors are worried the Treasury has effectively committed to open-ended borrowing,” says Chris Turner of ING Group. 

Pound to dollar parity is a serious outcome 

The probability of pound to dollar parity keeps rising and has reached 60% according to Bloomberg. 

This has more than doubled since Friday, when Bloomberg said the probability was 26%. 

"It’s hard to believe economists are talking about pound parity with the dollar. This will severely impact importers, and we buy in a lot more than we export,” says Samuel Mather-Holgate of advisory firm, Mather & Murray Financial.

Political uncertainty in the UK in the run up to Boris Johnson being forced to step down, and the subsequent Tory leadership race, further added to volatility. 

The fall in sterling also reflects concerns about the health of the UK economy and the increasingly high chance the UK will fall into recession later this year as inflation spirals out of control and energy prices remain high. 

Higher interest rates usually makes a currency more attractive, but the pound has been sliding hard. 

How will a weaker pound affect you?

Inflation

With oil and several other key commodities and imports priced in dollars, one of the biggest concerns is that a weak sterling will worsen inflation. Weaker sterling and a higher dollar makes the cost of imports more expensive and will raise prices at a time when all Britons are grappling with a cost of living crisis. 

Philip Dragoumis, owner of London-based Thera Wealth Manager, echoes this view: “If foreign investors lose confidence in the country, its government and economy, which is happening at scale, sterling could fall much further and the fallout will be devastating. This will keep inflation higher for longer and growth lower.”

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: “The plunging pound is effectively picking our pockets and making us poorer. The market reaction to the tax and spending plans announced on Friday will have a profound impact on everything from the cost of filling up the car and supermarket prices to debt repayments and the value of our savings.

Weaker sterling will have several ramifications for peoples’ money on areas such as savings, investments, spending and borrowing. 

Spending

Spending will almost certainly become more expensive. This is mainly through cost-push inflation which makes imports more expensive. If you are going on holiday then you will find that sterling will buy you nowhere as much foreign currency as it used to, especially if you are going to the US with the dollar surging. 

But Coles believes you can mitigate the impact by shopping around to get the best exchange rate for travel money

“Whether you choose a current account or credit card with no overseas fees, or buy your currency in advance for a better deal, you can get far more for your money than if you exchange your money as a last-minute afterthought at the airport”

Investments

As for how a weak sterling affects your investing, it depends on which companies and sectors you have invested in. But weak sterling is a double edged sword. As most companies in the FTSE 100 derive their earnings from abroad, a weak sterling can boost revenues as earnings will be worth more once converted back into sterling.

But any business that makes its money in the UK will face challenges, says Coles. 

“Retailers and other businesses who buy goods from overseas face rising costs. They can try to pass the higher cost of imported goods on to consumers, or they can try to cut their operating costs, but the speed with which sterling has fallen is going to make life horribly difficult,” she says. 

Savings

For savers, the falling pound will ring further alarm bells and mean further interest rate rises – including a potential emergency rate rise – is even more likely. This is likely to eat into returns. 

The key would be to shop around and find the best deals, especially for easy-access savings accounts

“You should also consider whether it makes sense to fix money you won’t need for the next year or so for [the] period that makes sense for you – in return for a better rate. At the moment, the one-year fixed-rate market is particularly competitive – with the best rates over 3.5%,” says Coles. 

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