The pound plunged to a record low against the dollar on Monday as investors worried about fresh budget spending from London. Decryption with the economist Jézabel Couppey-Soubeyran.
Great tumble for sterling. The British currency plunged on Monday to hit $1.0350 overnight: its all-time low dating back to 1985, when it hit 1.0520. By 11 a.m., the British currency remained down 0.88% but had risen to $1.0763. The explanations of Jézabel Couppey-Soubeyran, economist, lecturer at the University of Paris 1 Panthéon Sorbonne and specialist in monetary and financial economics.
How to explain this new decline of the pound against the dollar?
Liz Truss’ new government [la Première ministre conservatrice du Royaume-Uni depuis le 6 septembre, ndlr] announced quite significant support measures for households and businesses on Friday, without detailing how they would be financed. On the contrary, Liz Truss makes them coexist with corporation tax cuts. This means that in order to finance these measures, the UK will be forced to take on even more market debt. The markets thus expect a worsening in the ratio between debt and gross domestic product (GDP).
However, central banks are in the process of tightening their monetary policy and putting an end to asset purchases. So investors know that the government bonds they buy can lose a lot of value in the markets. Thus, they are again in a return/risk trade-off. The securities that represent the greatest risk must be those that give them the most return. In this context, the return/risk analysis of UK government debt securities is quite unfavorable. Specifically, it yields less and poses more risk than a US government bond. Consequence: investors prefer US debt to UK debt. They sell the British debt certificates and it is about to realize what they feared: the value of the securities falls.
What might the consequences of this plunge be for the British and their economy?
As investors flee investments in sterling, the British currency falls in the foreign exchange market. And as the pound falls in the currency market, imported inflation [lorsque le taux de change d’une monnaie se déprécie par rapport au dollar, le coût des produits importés augmente] in Great Britain is also strengthened. So all bills to be paid in foreign currency go up, especially gas, oil and fossil fuels which the UK is still quite dependent on. Vicious circles set in and contribute to investor distrust.
The fall of the British pound thus risks reinforcing British inflation, which is linked to deep structural factors: energy dependence, the slowness of the ecological transition. When the exchange rate falls, fossil fuel bills become more expensive, helping to “import” inflation. Liz Truss’ announcements are ambivalent: on the one hand she says she wants to protect British households from inflation linked to energy problems, but on the other hand she seems to question the ecological transition when these are the underlying factors of the current inflation rate. As a result, inflation will probably continue to rise, which may increase investor distrust.
What handles does Britain have?
To try to limit the fall in the British pound, the Bank of England (BoE) will no doubt intervene in the foreign exchange market, as the Bank of Japan (BoJ) did recently. It’s not in her missions, but she can do it from time to time when needed. The next meeting will take place in early November. The Bank of England is likely to meet earlier to also decide on a key rate hike to close the gap to the US, to bring longer-term rates back up and investors back into the UK market.
We can also expect the UK to use “financial deregulation” to retain investors or bring them back to its territory. At the moment, their communication operation is a little scary for those interested in financial stability. In order to attract investors to the UK market, they explain to us that they will remove the cap on banks’ bonuses and no doubt embark on a major financial deregulation operation. This promises major shocks in the financial markets.
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