ExplainerThe British pound has taken a tumble. What’s the impact?
- The British pound hit a record low against the US dollar on Monday, following a huge tax-cutting budget last week
- Britain is facing a cost-of-living crisis with soaring energy prices coupled with inflation and wage stagnation
The pound is taking a pounding.
Investors are spooked by a sweeping package of tax cuts likely to cost tens of billions of pounds in extra government borrowing and amounts to a risky gamble to stave off a looming recession.
But that’s not all. The currency chaos is playing out against the wider backdrop of the US dollar’s rally to a two-decade high.
Here’s a look at what it all means:
Many Britons are struggling amid soaring inflation driven by rising prices for food and energy, in a cost-of-living crisis that’s been dubbed the worst in a generation.
The pound’s slump threatens to make it even worse. One of the most visible ways is by feeding into the energy crisis because oil and natural gas is priced in dollars. The impact is being felt at the pump.
British drivers are paying £5 (US$5.45) more on average to fill up their cars since the beginning of the year as the pound has fallen, according to an analysis by motoring association AA. UK petrol prices would be at least 9 pence per litre cheaper if the pound was still at its mid-February level of US$1.35, compared with the now-outdated US$1.14 level that the group used last week for its calculation.
“There’s every chance that a falling pound will make life more expensive,” said Sarah Coles, senior personal finance analyst at financial services firm Hargreaves Lansdown. Anything bought from overseas – components, raw materials, supermarket staples and household basics – will be pricier.
“These rising costs will feed into higher prices, and push inflation even higher,” Coles said. “For anyone whose budget was already stretched to breaking point, this will mean even more pain at the tills.”
Finance minister Kwasi Kwarteng hopes that big tax cuts will spur economic growth and generate wealth, but the sliding pound raises the possibility that will be offset if the central bank steps in with bigger-than-expected interest rate increases.
Some analysts are speculating rates could rise as high as 6 per cent by next spring, a sharp contrast to the near zero level they were at just a few years ago. Rising rates mean many homeowners face bigger monthly mortgage bills, leaving them less likely to spend on other goods and services.
How low can it go?
Fifteen years ago, £1 was able to buy US$2. Now, the pound is getting closer to parity with the US dollar, a once-unthinkable event and a psychologically important milestone. The pound has tumbled more than 5 per cent since the government outlined its economic plans Friday, dropping as low as US$1.0327 early Monday, before bouncing back to above US$1.06.
The markets are raising the prospect that the two currencies might soon reach equal footing. A lot of the decline has been driven by the strength of the dollar, which has climbed against a wide range of other currencies as the US Federal Reserve aggressively raises rates, drawing interest from investors fleeing riskier assets.
The euro, for example, has been on a similar trajectory to the pound, having fallen below parity with the dollar recently and then hitting a fresh 20-year low Monday.
The pound has dropped more than most, though, because of local factors. Investors are alarmed at Kwarteng’s “lack of focus on fiscal prudence”, which outweighs any optimism about his pro-growth, anti-red tape agenda, said Victoria Scholar, head of investment at interactive investor.
“On top of being bullish towards the dollar, the international investor community is now also very bearish towards the pound amid fears about the UK’s economic outlook and investment case,” Scholar said.
Tug of war
The plummeting pound highlights what analysts are calling a “tug of war” between Britain’s Treasury and the central bank, which has independence from the government to operate free of political influence.
The Truss government is gambling that slashing taxes and borrowing more to pay for it will kick-start economic growth as a recession looms.
That puts government officials at odds with the Bank of England, where policymakers are trying to rein in inflation that threatens financial stability by raising interest rates, with seven hikes so far this year and more in the pipeline.
The central bank said Monday that it wouldn’t hesitate to raise interest rates by as much as needed at its next meeting in November, which did little to soothe markets. An interim meeting to decide on an emergency rate hike could be needed, “though that would risk escalating tensions with the new government,” said Jeremy Lawson, chief economist at asset manager abrdn.
“There are no good options from here, just less bad ones, with the UK’s already struggling household and businesses left to pick up the pieces,” Lawson said.
Is there any upside?
British exports will be cheaper for buyers paying in dollars. But the economic impact is likely to be limited, given that the United Kingdom runs a trade deficit with the rest of the world by importing more than it exports.
It’ll be a lot cheaper for foreign visitors. Pub beers, theatre tickets for shows in London’s West End and hotel bills will be more affordable for tourists.
“I have been here four weeks. The change in exchange rate is round about 5 per cent so I will get 5 per cent more. It enables me to buy another pint,” said Australian Tony Cosford.
And for investors and wealthy people, the slumping pound makes it cheaper to buy real estate in Britain, especially in exclusive London neighbourhoods that have long been favoured by the global super-rich.
Additional reporting by Reuters