The British pound took a beating Monday, reaching a record low against the U.S. dollar. The plunge came as markets reacted to the new U.K. government’s plan to deliver the biggest tax cuts in 50 years while simultaneously boosting spending.
“High tax rates damage Britain’s competitiveness,” U.K.’s new finance minister Kwasi Kwarteng said Friday when announcing tax cuts across the board.
According to an independent analysis by the Institute for Fiscal Studies, the tax cuts will cost an estimated £45 billion a year by 2027, while a previously-announced energy relief plan could cost £60 billion over the next six months. Kwarteng plans to plug the ensuing deficit with increased public borrowing at a time when interest rates are rising.
The news sent sterling down near $1.03 against the dollar on Monday before rebounding slightly later in the day. A pound near parity with the dollar means American travel to the U.K. is cheaper, but for the U.K., a low pound means it costs more to import commodities like oil and gas — which are priced in dollars — right when the region is facing an energy crisis and high inflation.
“My view is, we absolutely need to be incentivizing growth at what is a very, very difficult time for the global economy,” U.K. Prime Minister Liz Truss said on CNN.
The Truss government hopes the “mini-budget” and tax cuts will increase investment in the U.K., boosting revenue. But the IFS is bringing attention to a more near-term problem.
“Injecting demand into this high-inflation economy leaves the government pulling in the exact opposite direction to the Bank of England,” economist and IFS director Paul Johnson said.
The pound’s rout on Monday put pressure on the Bank of England to take aggressive action to calm the volatility, including calls to announce an emergency rate hike. At the end of London’s trading day, the Bank settled on releasing a statement instead.
“The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets,” Governor Andrew Bailey said. “The MPC will not hesitate to change interest rates as necessary to return inflation to the 2% target sustainably in the medium term.”