British pound falls to record low, sparking rate hike speculations

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The pound fell to a record low against the U.S. dollar early Monday, fueling speculation that the Bank of England might raise interest rates to prop up the currency.

The sterling fell almost 5 percent to drop below the 1985 trough at $1.0327, before recovering to $1.0605. It is still down more than 2 percent on the session.

On Friday, the pound fell more than 3.5 percent against the dollar, after the new government announced the biggest tax cuts in 50 years.

Investors are not impressed by debt-financed tax cuts at a time when interest rates are on the rise. They also sold off U.K. government debt. ING economist Antoine Bouvet said plans by Chancellor Kwasi Kwarteng had created “a perfect storm for U.K. gilts and FX.”

“Kwarteng threw the BoE a bomb and now they have to respond — today, asap … rate hikes incoming,” said Chris Weston, head of research at Pepperstone.

Former Bank of England Monetary Policy Committee member Adam Posen also expects rates to go up, after a possible, futile attempt by the Treasury to intervene in forex markets to prop up the pound. “But I would expect — and encourage — the Governor/MPC to say publicly by mid-week that if GBP down, rates up,” he tweeted.

The Bank of England on Thursday raised rates by 50 basis points and made explicit reference to a pending announcement that would likely “contain news that was material for the economic outlook.”

A falling pound is a particular concern for the Bank of England as it challenges its fight against rampant inflation by boosting the cost of dollar-denominated energy imports. The lower the pound, the more interest rates have to rise.

In an interview with the Financial Times over the weekend, Kwarteng dismissed concerns over ensuing market turmoil. “Markets move all the time. It’s very important to keep calm and focus on the longer-term strategy,” he said. Nor did he see a conflict between the Bank of England’s tightening of monetary policy to control rampant inflation and the fiscal authority’s spending spree.

The euro also hit a 20-year low against the greenback to trade at $0.9655, as the victory of a right-wing coalition in Italy on Sunday compounded lingering recession fears.

Source: Politico