City braces for more volatility after mini-budget rocks pound

City investors are bracing for more volatility after the bonanza of tax cuts and spending measures in Kwasi Kwarteng’s mini-budget threatened to undermine their confidence in the UK. The odds of the pound hitting parity with the US dollar, for the first time ever, have jumped after sterling slumped below $1. 09 on Friday as traders grew increasingly anxious about the UK’s budget and current account deficits.

Chris Weston, the head of research at the brokerage firm Pepperstone, said the pound was “the whipping boy” of the G10 foreign exchange market, while the UK bond market was “getting smoked” thanks to Kwarteng’s £45bn debt-financed tax-cutting package. “The funding requirement needed to pay for the mini-budget means either we need to see far better growth or higher bond yields to incentive capital inflows,” Weston said. Targets that the pound could fall below $1.

05, for the first time ever, were being “liberally thrown around”, he added. After such a dramatic week in markets we look ahead to a huge week of central bank speakers – will risk rally or will markets go after a response as the ability to price risk is so uncertain? A few thoughts on the trading landscape & the big talking points #trading #market #USD pic. twitter.

com/vUUUR1ig6b — Chris Weston (@ChrisWeston_PS) September 25, 2022 Kwarteng’s mini-budget caused a rout in UK financial markets on Friday. Sterling shed four cents to hit a 37-year low of $1. 0856, while the jump in the cost of government borrowing was the biggest in a single day in decades.

Sterling fall against the US dollar grapic “The price of easy fiscal policy was laid bare by the market,” said Sanjay Raja , chief UK economist at Deutsche Bank. He said Kwarteng’s tax cuts were adding to medium-term inflationary pressures and were “raising the risk of a near-term balance of payments crisis”. “A plan to get the public finances on a sustainable footing will be necessary but not sufficient for markets to regain confidence in an economy sporting large twin deficits,” Raja said.

The UK current account deficit, which includes the trade balance and the net income from foreign investment and transfers, had already widened to a record level this year. The jump in the cost of imported energy is adding to this deficit, which is pushing the pound down towards levels that make UK assets attractive to foreign buyers again. On Friday afternoon, Bloomberg’s options pricing model showed there was a 26% chance the pound and the dollar hitting parity within the next six months, up from 14% on Thursday.

UK FX and bond markets crashed. . .

GBP lowest since 1985 “According to Bloomberg’s options pricing model, the pound holds a 26% chance of touching parity versus the greenback in the next six months. . .

” pic. twitter. com/1HvC2uPKYM — Caroline Hyde (@CarolineHydeTV) September 23, 2022 Nouriel Roubini, the economist who predicted the 2008 financial crisis, warned bluntly that the UK was starting to be priced like an emerging market, and was heading back to the 1970s.

“Stagflation and eventually the need to go and beg for an IMF bailout … Truss and her cabinet are clueless,” he tweeted. But Paul Krugman, a Nobel economics laureate, pointed out that the pound’s depreciation actually improved Britain’s net international investment position. Krugman said a 1970s-style sterling crisis was unlikely to occur unless the Bank of England chooses to monetise the debt, rather than offsetting the fiscal stimulus with tighter monetary policy.

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I’ve been getting emails from City economists who agree that balance sheet effects won’t be a problem, but are worried that the BoE will not, in fact, offset the fiscal stimulus — that it will in effect monetize deficits 1/ https://t. co/2ybbKV1Suo — Paul Krugman (@paulkrugman) September 25, 2022 Kwarteng tried to play down the financial reaction to Friday’s mini-budget, telling BBC One’s Sunday with Laura Kuenssberg he was focused on boosting longer-term growth, not on short-term market moves, “As chancellor of the exchequer, I don’t comment on market movements. What I am focused on is growing the economy and making sure that Britain is an attractive place to invest,” he said.

The Bank of England is expected to raise interest rates higher to combat the inflationary impact of the mini-budget, as a weakening pound drives up costs of imports. The money markets are pricing a doubling of UK interest rates to more than 5% by next summer. “Conservative MPs are asking themselves whether Mr Kwarteng has been brilliant or bonkers.

The markets are saying bonkers,” said David Blanchflower, a former member of the Bank’s monetary policy committee. Blanchflower said he feared Kwarteng’s “reckless attitude” could encourage investors to “keep selling UK plc”. After the mini-budget, the UK Debt Management Office plans to raise an additional £72bn before next April, raising the financing remit in 2022-23 to £234bn.

“Sterling is in the firing line as traders are turning their backs on all things British,” said David Madden, a market analyst at Equiti Capital. “There is a creeping feeling the extra government borrowing that is in the pipeline will severely weigh on the UK economy. ” The FTSE 100 tumbled 2% to a three-month closing low on Friday.

So far this year, the index of blue-chip companies has lost 5% – much less than European or US markets – helped by oil companies, and exporters boosted by the weak pound. “The chancellor’s high-risk strategy could entail a larger FTSE 100 correction before the year is out,” said Charles Archer, a financial writer at online trading platform IG . “As monetary policy tightens, mortgage and debt defaults rise, while investment in growth falls.

This could render the mini-budget entirely ineffective. ”.