On 6 September, in London, England, newly inaugurated British Prime Minister Elizabeth Truss (former) arrived at the Prime Minister's Office at 10 Downing Street. Photo/Xinhua News Agency
On September 26, local time, the pound against the US dollar exchange rate fell to 1.0327 US dollars in early trading, hitting a 37-year record low. The pound also fell to 1.0787 euros against the euro, the lowest level since September 2020.
All of this is related to the newly announced tax cut fiscal measures in the United Kingdom. The decline in stock prices in various countries has caused strong dissatisfaction among global investors.
The consequences of the collapse of the pound sterling are revealed
The pound has been on a soft side since the UK cabinet crisis.
As Terras took office on September 6, the pound had fallen by about 7 percent against the dollar by last week's Black Friday. This is partly due to the lack of confidence in the new Tlas Cabinet's ability to govern the finances, and partly because the United States continues to raise interest rates and protect the dollar exchange rate to calm inflation.
A series of chain reactions followed: on the 27th, the British 10-year Treasury yield rose to a new high since the end of 2008 at 4.377%, up 12 basis points during the day; Shorter Treasuries have not been spared, with yields rising sharply to 4.6% in five years – up from around 3% earlier this month.
On the same day, British banks withdrew mortgage transactions, resulting in a sharp decline in the shares of home builders, and the shares of several major British real estate developers fell.
As some senior analysts have said, people have been mentally prepared for the weakening of the pound, but in any case could not have expected such a rapid and large collapse. The Guardian could not help but lament that "(the pound) of this gem has lost its luster".
Gas bills and some coins for a family in London, England. Photo/Xinhua News Agency
"Minimal measures" will not appease volatile markets
Many analysts point to the new Prime Minister Truss's campaign promises, such as the implementation of steep tax cuts, that led to the collapse of the pound.
Among the candidates for the leadership of the Conservative Party, only the former Chancellor of the Exchequer, Sunak, who entered the final showdown and lost to Truss, opposed the tax cuts, and he also made a plan to increase taxes when he was the Chancellor. Other candidates, who speak softly or realize they can't "push too hard," are far less loud than Truss when it comes to shouting "tax cuts."
Many analysts believe the promise of tax cuts is Terras's most powerful campaign talisman. Therefore, after Terrass officially became prime minister in early September, the market also concluded that he would implement the tax cuts, but also judged that he would choose to raise interest rates more sharply to hedge the inevitable lack of revenue from the national treasury caused by the large tax cuts.
On September 22, the Bank of England belatedly announced a 50-basis-point rate hike, raising interest rates to 2.25%. Although it has reached the highest level in 14 years, it is still far from the market forecast.
On September 23, the British Chancellor of the Exchequer announced a much larger than expected, the largest tax cut in the UK in 50 years, but failed to announce the sharp interest rate hike "hedge" expected by the market, and even did not clearly predict that interest rates would be raised, resulting in great disappointment in the market and investors.
Fortunately, the ensuing weekend gave the British government a breathing breath and time to remedy, and the market once again made the expectation that "the central bank will remedy it on Monday", believing that even if an emergency interest rate hike is not announced, at least a policy statement will be issued that "it will make a decision to raise interest rates as soon as possible".
However, Monday arrived as promised, but the market's expectations were not met.
On September 26, just 14 hours before the close of the previous round of sharp exchange rate declines, Bank of England Governor Pele delivered a vague and ambiguous tone speech in anticipation. He said the central bank "is monitoring financial market movements very closely" and will "not hesitate to adjust interest rates if needed, so that inflation can return to the 2% target sustainably over the medium term."
What's more, Pele is clearly signaling that neither the cabinet nor the central bank intends to make a decision to adjust interest rates before the next policy announcement in November.
Some Fed officials pointed out that the British policy side only came up with "minimal measures" to try to appease the market at a critical moment when the crisis had already erupted, and the result was to stimulate the market to react contrary to its wishes.
Bank of England. Photo/Xinhua News Agency
Some anonymous analysts close to the conservatives in the British parliament pointed out that Truss's campaign platform of "cutting taxes and not wanting to reduce government spending" is contradictory and difficult to implement. Her new official is in office, and she is afraid that a sharp interest rate hike will affect the support of mortgage lenders and drag down GDP growth, resulting in a fear of death at a critical juncture.
In the selection process for the head of the party, the Conservative Party members who have the right to choose the new prime minister in the final "two-choice one" vote have chosen their favorite commitments after being repeatedly reminded that "Terras's promise has a hard wound", and now it can only be said that such a result can only be said to be benevolent.
Stopping the pound from falling is not so simple
The collapse of the pound sterling has become a fact, and the traditional response is nothing more than to reduce the sale of Phnom Penh's government bonds, directly intervene in the exchange rate and wait for the laws of the market to work.
Reducing the sale of Phnom Penh Treasury bonds may be the least costly option.
But many in the industry believe the move may run counter to the government's goal of keeping inflation below 2 percent, and in part a breach of Truss's original campaign promises. Judging from the market reaction in the past few days, the yield of 5-year and 10-year Treasury bonds has risen sharply, and if the "water control" continues, it will lead to an increase in the cost of government borrowing.
Direct intervention in the market has the most immediate effect.
Japan's intervention in the market last week was seen as helping the yen's exchange rate stabilize — but the premise of intervention in the market was an abundance of foreign exchange reserves. When Japan decided to "sell", its foreign reserves were as high as $1.17 trillion. At the end of August, Britain's foreign exchange reserves were only $108 billion, and once it intervened half of it "ran out of bullets", the United Kingdom would be in an embarrassing dilemma.
"Let the laws of the market work" is more uncertain. Some schadenfreude French financiers have pointed out that "the performance of the pound on the 23rd and 26th is the result of the laws of the market".
The British Parliament building at sunset. Photo/Xinhua News Agency/Midland
Terras's external adviser said helplessly after the 26th crash that the central bank needs to take "some measures" on the one hand, and the new finance minister must also convince the public and the market as soon as possible that the tax cut is only part of its story and far from all (meaning that there are other good ways), otherwise market confidence will be difficult to stabilize, and the pound sterling exchange rate will not be stable. "Because the market clearly does not believe that the fiscal easing advocated by central banks is necessary, non-inflationary and affordable," he said.
The problem is that less than a month after the Tlas team took office, the public (including the Conservatives who voted to make her the party leader and prime minister) already understood after a sharp decline in wealth that the tax cuts were indeed far from the "Truss package", but what could be done?
Written by / Tao Shorthouse (Columnist)
Editor / Yunyun Liu
Proofreading / Zhao Lin