Explained: Why The British Pound Hit A Record Low Against The Dollar

The sterling pound fell to a record low against the dollar on Monday, dropping to as low as $1.0327 during morning trade before recouping the $1.05 level.

What Happened: Investors and traders were spooked as Britain’s new Chancellor of the Exchequer Kwasi Kwarteng announced the biggest package of tax cuts in 50 years last week in what has been dubbed the “mini-budget”. 

Kwarteng said there is a need for a major change of direction to boost economic growth. He cut income tax and stamp duty on home purchases and did away with a planned hike in business taxes.

What seemed to have hurt the pound is Kwarteng's vow to cut more taxes.

Also Read: What Historic UK Tax Cuts Mean For The Markets: 'Material Increase In Risks'

Kwarteng announced a reduction to the top rate of income tax from 45% to 40%, which means the UK will have a single higher rate from April.

“We’ve only been here 19 days. I want to see, over the next year, people retain more of their income, because I believe that it’s the British people that are going to drive this economy,” Kwarteng said, according to Bloomberg.

Why It Matters: Taxes are a major source of fiscal income. Indeed, a reduction in taxes is important to push growth, but traders and investors seem to be unconvinced by the new policies, mainly for two reasons.

Firstly, such a drastic tax cut could likely lead to a wide fiscal deficit. And there’s a double whammy here. With asset prices falling, yields on U.K. bonds or gilts are also rising, which means the government will have to shell out a higher interest rate to borrow funds from the market to plug the potential deficit.

The Crash: The bulk of the pound’s crash came in about 20 minutes on Monday, reported Bloomberg, noting that it was the biggest intra-day since March 2020. Option markets indicate that the odds of the pound falling to parity with the dollar this year have risen to 63%, the report said.

Expert Take: “Considering the relatively low FX Reserves and ghost of the past (Black Wednesday), BoE may be reluctant to intervene in FX markets. It would be a desperate move and would embolden speculators further. An out-of-policy rate hike is more likely,” IFA Global Research said in a note.