Sterling had its worst day on record after Kwasi Kwarteng’s tax cut bonanza sparked concern among economists and investors.
Falling by at least 4.7%, it fell to its lowest level since decimalization in 1971, when pence and shillings were put on hold.
“Sterling looks like an emerging market currency, especially when you look at the price of the British pound a few months ago and compare it to where it is today,” said Naeem Aslam, chief market analyst at Avatrade.
But why has the pound fallen and what does that mean for you and for the economy?
Continue reading: The pound falls to an all-time low against the dollar as Kwarteng signals more tax cuts
Why is the pound falling?
On Friday, Kwarteng depreciated the currency, falling to a 37-year low shortly after his first financial announcement since taking office as chancellor.
However, that was only the beginning. Sterling broke all records in the early hours of Monday, falling to an all-time low of $1.0327 against the dollar before regaining some ground to $1.05.
The run followed additional comments from Kwarteng over the weekend, which has fueled concerns about additional debt-filled tax cuts after he hinted that “more are to come”.
Investors and economists fear the government’s plans to increase borrowing come at a time when interest rates are rising, meaning debt will not only get bigger, but also more expensive.
The mini-budget puts national debt as a percentage of gross domestic product on track to hit 92.4% in five years, Capital Economics estimates, defeating budget plans put forward by Boris Johnson’s government that said debt levels would rise within three years should decrease.
Kwarteng’s pledge of more tax cuts suggests he won’t bow to market pressures, even promising to present a medium-term fiscal plan on November 23 to convince investors that debt will come down.
Investors, already worried about the state of government finances and the money needed to fund budget plans, have been further alarmed by Kwarteng and Prime Minister Liz Truss’ target to meet their 2.5% annual growth target.
Continue reading: Mini budget: “Trussonomics” astounds investors as a bond and pound tank
What can you do about it?
Analysts have urged the Bank of England to step in and raise interest rates to stave off a further decline and potentially prevent the pound from reaching par with the dollar – or worse, falling below par.
An emergency rate hike could help support stering and prevent the market panic from spiraling out of control.
But there is also a risk of panic arising. Governor Andrew Bailey and the Monetary Policy Committee raised interest rates to a post-financial crisis high of 2.25% last week in a bid to cope with the highest inflation in 40 years.
On Monday evening, the BoE ruled out an emergency meeting, but Bailey said in a statement: “The MPC will not hesitate to change interest rates by as much as needed to bring inflation back to the 2% target on a sustainable basis over the medium term.”
Watch: Pound tumbles as UK financial plan rocks markets
UK inflation could surge higher as analysts warn that the pound’s plunge towards parity with the dollar could further push up the cost of goods and potentially exacerbate the cost of living crisis.
Samuel Tombs, an expert at Pantheon Economics, said on Thursday that inflation is likely to rise by around 0.5% in 2024 due to the sterling’s recent fall.
This means that every £1,000 a family spends is worth £5 less simply because of the fall in the pound, making the average household worse off by around £150 each year – resulting in runaway inflation, currently at 9.9 % contributes.
Products imported into the UK, such as those used in the food and drink industry, could become more expensive, potentially resulting in a price increase that is passed on to customers.
Kantar experts said food inflation rose 12.4% in August as the food and beverage industry was already under pressure from energy cost increases.
Carlsberg Marston’s Brewing Company chief executive officer Paul Davies said the pound’s fall to a record low was “of concern” for the beer sector, which imports beer and hops.
energy and fuel costs
Energy bills and fuel costs are likely to rise if the pound falls, as gas used in the UK is priced in dollars – even if it’s produced in the UK.
Watch: How does inflation affect interest rates?
Holiday trips are becoming more expensive, especially in the US and other countries against which the pound has fallen.
Holidaymakers worried about the pound’s depreciation have been urged to “watch price movements carefully”.
Nick Boden, head of foreign exchange provider Post Office Travel Money, warned that “sterling’s volatility makes it impossible to predict how exchange rates will behave over the coming weeks”.
The $500 purchase cost around £480 at some points throughout the day, compared to around £440 on the same day last week.
“Our advice to people planning international travel is to keep a close eye on price movements in the weeks leading up to your departure and change money at times when prices are rising,” Boden said.
Airlines are also facing higher bills for purchasing fuel and leasing aircraft. Airlines pay a large portion of their costs, such as fuel, in US dollars, which could push up airline ticket prices.
EasyJet (EZJ.L) chief executive Johan Lundgren admitted the pound’s depreciation is having “an impact” on his finances.
“The dollar is clearly very strong against the pound,” he said in a speech at the airline’s headquarters at Luton Airport. “It’s having an effect. We have a lot of expenses in dollars and income in pounds.”
However, with the euro falling to a 20-year low, currency changes are unlikely to make holidays to the continent much more expensive, meaning it’s cheaper for tourists to come to the UK.
Continue reading: Kwasi Kwarteng announces biggest tax cuts since 1972 in Britain’s growth spurt
What it means for personal finances
While higher interest rates tend to attract savings to the UK and thereby boost the value of the pound, the cost of borrowing for households and businesses could rise.
Experts warn savers are “likely to lose more of the value of their savings”.
“As the falling pound is likely to push inflation higher, it means savers are likely to lose more of the value of their savings once inflation is factored in,” said Sarah Coles, senior personal finance analyst at Hargreaves Lansdown. “If you leave your money in an easily accessible main account that pays less than half a percent, runaway inflation will very quickly erode the purchasing power of your money.”
Watch: Why are gas prices rising?
What it means for private investors
Although the impact of Sterling’s fall depends on the type of investor’s assets, the FTSE 100 (^FTSE) typically benefits from a weaker pound.
That’s because most of the big companies listed in the London blue-chip index make most of their money abroad, which is worth more when converted back into pounds.
But businesses making their money in the UK face challenges.
Coles added: “Retailers and other businesses sourcing goods from overseas face rising costs.
“They can try to pass the higher cost of imported goods on to consumers, or they can try to reduce their operating costs, but the speed at which sterling has fallen is going to make life terribly difficult.
“Therefore, the more domestically oriented FTSE 250 (^FTMC) should be more sensitive to the weaker sterling.”
Continue reading: Bank of England rules out emergency interest rate meeting
Bonds and Gilts
The chancellor’s debt-fuelled mini-budget on Friday sent sterling and UK bonds into a meltdown – but things only got worse on Monday.
The UK has suddenly become a riskier bet, with traders dumping UK assets, selling the pound and raising government borrowing costs in the wake of the declaration.
UK 5-year government bonds are now priced below Italy and Greece, a decade after the euro-zone debt crisis swept through markets. Yields rise when bond prices fall.