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British Pound Sinks as Markets React to U.K. Government Tax Cuts

Britain’s new government announced a sweeping series of tax cuts on Friday, assuming it had found its way to economic growth despite high inflation.

But market judgment was quick and negative: UK equities, bonds and the pound plunged to new lows against the US dollar, not seen since 1985.

The plans require large increases in government borrowing and have raised expectations that the Bank of England will have to raise interest rates even more aggressively to halt inflation. This will further increase the cost of these tax cuts and previously announced spending plans to protect households and businesses from rising energy costs.

Following the announcement by the new Chancellor of the Exchequer, Kwasi Kwarteng, the FTSE 100, Britain’s main stock index, fell 2 percent.

But the most notable market moves were those of UK government bonds and the pound.

Bond yields, a measure of borrowing costs, shot higher, making the interest the government pays on the new debt it issues much more expensive. The yield on benchmark 10-year government bonds climbed to its highest level since 2011. And the yield on the five-year bond rose about half a percentage point to 4.05 percent, a huge move in a market where daily changes are typically measured in hundredths of a percent. a point.

“It’s fair to say that the gold market hated the current mini-budget,” Jim Leaviss, a bond investor at M&G Investments, said in email comments, referring to the UK government bond market.

“In what was already a weak period for government bonds thanks to global inflation and interest rate hikes by central banks, the UK stood out as an underperformer,” he added.

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The pound also fell 2 percent against the euro on Friday and fell more than 3 percent against the US dollar to $1.09. The British currency has lost more than 19 percent against the dollar this year.

“Concerns about the UK budget position, combined with the recession outlook and extremely high inflation, make the pound extremely vulnerable,” analysts at Rabobank wrote in a note.

Mr Kwarteng outlined the government’s plan in a statement to a crowded Parliament, promising to accelerate economic growth through a combination of tax cuts and deregulation, as in the 1980s under Prime Minister Margaret Thatcher. But the emphasis on lower taxes for businesses and workers comes as the government prepares to spend £60 billion over the next six months to subsidize energy costs for households and businesses, the first phase of a comprehensive plan to reduce the cost of gas and electricity for consumers.

“The markets are reacting as they want,” Mr Kwarteng said in the House of Commons on Friday. “But the growth plan will very soon show that we are on the right track and we are steering towards a more prosperous future.”

Investors seemed concerned about Britain’s fiscal condition before the details of the new government’s plan were revealed by Mr Kwarteng. Britain’s budget and balance of imports and exports make the country dependent on what a previous central bank governor called “the kindness of strangers” to fund economic plans.

“Sterling is in danger,” warned Deutsche Bank analysts, who have been worried for weeks about investors losing confidence in Britain and unwilling to fund the current account deficit. “We are concerned that investor confidence in the UK’s external sustainability will soon be eroded. And the only thing that can prevent the pound from weakening is a very aggressive walk cycle from the Bank of England.”

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