Sterling tumbled to a record trough on Monday and British bond prices collapsed, prompting speculation of emergency response from the Bank of England (BoE), as traders scampered for the exits on speculation the new government's economic plan would stretch Britain's finances to the limit.
New Treasury chief Kwasi Kwarteng sent sterling and government bonds into freefall on Friday with a so-called mini-budget that was designed to grow the economy by funding tax cuts with huge increases in government borrowing.
The pound’s searing drop helped the safe-haven U.S. dollar to a new two-decade peak against a basket of major peers.
Sterling slumped as much as 4.9% to $1.0327, its weakest since at least the introduction of decimalization in the early 1970s, before it pared losses in European trading.
It dropped 3.6% on Friday, when Kwarteng unveiled historic tax cuts funded by the biggest increase in borrowing since 1972.
"Sterling is getting absolutely hammered," said Chris Weston, head of research at Pepperstone. "Investors are searching out a response from the Bank of England. They’re saying this is not sustainable."
Mohamed El-Erian, a chief economic adviser at Allianz, said the BoE would have no choice but to raise rates if the government of Prime Minister Liz Truss did not back down.
"And not by a little, by 100 basis points, by one full percentage point to try and stabilize the situation," he told BBC Radio.
Truss, who took office less than three weeks ago, is racing to combat inflation at a nearly 40-year high of 9.9% and head off a prolonged recession. Facing a general election in two years, she needs to deliver results quickly.
'Incredibly worried'
Kwarteng has so far declined to comment on the market turmoil, and a person close to the finance minister said he was unmoved by the reaction.
"Markets go up and down," one veteran Conservative party source said, declining to be named. "We did something structural, short term, that will have seismic and positive long term benefits."
However, the scale of the market turbulence has started to rattle some in the party, with one lawmaker saying mainstream Conservatives were getting "very worried," as constituents emailed their local politicians to express alarm.
Rachel Reeves, a former economist at the Bank of England (BoE) who is now the financial policy chief for the opposition Labour Party, said she was "incredibly worried" by the reaction of markets and Nicola Sturgeon, the first minister in Scotland, called for the UK parliament to be recalled.
Investors and analysts were more direct.
"The British have decided that going back to the 1980s on steroids is the best way to go, and clearly the market is just saying: 'That's not going to work,'" Michael Every, Rabobank strategist, said.
"The market is now treating the U.K. as if it's an emerging market. And they're not wrong in terms of the policy response and the naivety of thinking that boosting demand rather than supply is how you deal with a supply-side shock."
The pound had rebounded to $1.08 as of 11:44 a.m. GMT, but there was no sign of recovery in gilts.
The euro also touched a fresh 20-year trough to the dollar on simmering recession fears, as the energy crisis extends toward winter amid an escalation in the Ukraine war. It was also overshadowed by Italy’s election of its most right-wing government since World War II. Some investors were relieved at the relatively poor performance of euro-sceptic coalition partners, though it was no help to the euro.
Europe’s shared currency slid as low as $0.9528, and last traded down 0.71% at $0.9623.
The dollar built on its recovery against the yen following the shock of last week’s currency intervention by Japanese authorities, as investors returned their focus to the contrast between a hawkish U.S. Federal Reserve (Fed) and the Bank of Japan’s (BOJ) insistence on sticking to massive stimulus.
The dollar index – whose basket includes sterling, the euro and the yen – reached 114.58 for the first time since May 2002 before easing to 114.02, 0.78% higher than the end of last week.
"The dollar strength was in large part because of the heavy selling of the sterling," said Saktiandi Supaat, regional head of FX research and strategy at Maybank.
"It’s more of a risk-off sort of thing," Supaat added. "Global recession fears have actually intensified and widened quite broadly."
The dollar added 0.54% to 144.175 yen, continuing its climb back toward Thursday’s 24-year peak of 145.90.
Doomsday cult
Paul Donovan at UBS said investors seemed "inclined to regard the U.K. Conservative Party as a doomsday cult."
Markets currently show investors are placing an 88% chance on the BoE raising rates by a percentage point to 3.25% at its next meeting in November, according to Refinitiv data.
The debate between some economists was whether an emergency rate hike would sow yet more panic, or calm markets.
Andrew Sentance, a former BoE policymaker, told Sky News he did not advocate an emergency meeting. "I think that would add to the sense of nervousness and panic rather than calming it down," he said.
Further highlighting the extent to which investors have punished U.K. assets, the difference in the 10-year borrowing costs for the British and German governments exploded to its widest since 1992, when the U.K. crashed out of the European Exchange Rate Mechanism.
British government bond prices are now on track for their biggest slump of any calendar month since at least 1957, according to a Reuters analysis of Refinitiv and BoE data.
In response to that statistic, Paul Johnson, the head of the Institute for Fiscal Studies, attacked the government's decision to ignore the usual rules. "This will cost billions," he said on Twitter. "Economic and fiscal constraints are real. It's not just 'Treasury orthodoxy.'"