The UK pound's exchange rate against the US dollar fell as low as 1.0327 in early trading on Monday, a 37-year low. The pound also fell against the euro to 1.0787 at the same time, the lowest since September 2020.
This is related to the newly announced tax cuts in the United Kingdom. And falling share prices caused by the fall of the pound's exchange rate around the world have caused an outcry among global investors.
The pound has fallen about 7 percent against the dollar since Liz Truss took office as prime minister on Sept 6. That is because the market has little faith in the new Truss Cabinet's fiscal stewardship, as well as the fact that the United States has continued to raise interest rates and is protecting the dollar in an effort to tame inflation.
A series of knock-on effects have followed: the yield on British 10-year gilts rose to 4.377 percent on Tuesday, the highest since late 2008, up 12 basis points on the day. Shorter-dated gilts have not been spared either, with yields on five-year bills rising sharply to 4.6 percent — up from around 3 percent earlier this month. Shares of housebuilders tumbled on the same day as banks pulled back on mortgage deals, and shares in some of Britain's biggest property developers fell at the same time.
As some senior analysts have said, people had been prepared for sterling's weakness, but not for such a swift and dramatic collapse. To some extent, it was Truss' election promises, such as the big tax cuts, that have led to the pound's collapse in a short time.
After Truss took office, the market assumed she would follow through on the tax cuts, but also that she would opt for a bigger rise in interest rates to hedge against the deficit that it would inevitably lead to. On Sept 22, the central bank belatedly announced a half-point rise in interest rates, taking them to 2.25 percent. Although that is the highest in 14 years, it was still much lower than the market's forecasts. One day later, the chancellor of the exchequer disappointed markets and investors when he announced the much bigger than expected tax cut, Britain's biggest in 50 years, but failed to accompany it with the big "hedge" of interest rate rises that markets had been expecting.
Now it is clear that Truss cannot realize her election objectives of cutting taxes without cutting government spending. Her reluctance to grant a sharp rise in interest rates originates from her fear that it will undermine the support of mortgage holders and drag down economic growth.
What the UK is reaping now is exactly what the Conservative Party has sown. Its members knew what she was promising was unfeasible.
It takes much more than sound bites and cosmetics to carry on the legend of the "Iron Lady".
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