Pounded

Pounded:

Overnight trading has seen sterling sunk to its lowest level against the USD since decimalisation in 1971, hitting $1.0350 – a slump of some 4.7% ?– and smashing through the previous all-time low of $1.050 reached in 1985. Sterling has now lost well over 20% of its value against the dollar on a year-to-date basis, as the UK’s currency is marked as the worst-performing amongst the G10 this year.

As speculation continues on a possible emergency interest rate hike to bring some support to sterling, the currency has seen something of a bounce, though – as Bloomberg are reporting – markets are “expecting extreme turbulence, with sterling-dollar’s three-month implied volatility surging 4.31 percentage points to 20.05%” this morning. This means that the three-month implied volatility measure is close to the highs reached during the pandemic, when the country went into lockdown.

Major Reaction to not-so-‘Mini-Budget’:

Sterling’s overnight slump comes as a continuation of the market reaction to Kwarteng’s financial statement on Friday, which unveiled ￡45bn of debt-financed tax cuts and spending. Market speculation also continues around the extent to which the government will intervene in alleviating pressure on household’s energy bills, which some analysts predict could amount to ￡150bn, thus putting further strain on the public’s finances. Though falling gas prices mean that the cost of government intervention is theoretically falling, ongoing volatility in wholesale markets and growing concerns regarding the Russia-Ukraine conflict, mean that No.11 are far from being out of the woods as the prospect of rising prices remain.

Kwarteng’s not-so-‘mini’-budget involved the basic rate of tax being cut from 20p to 19p from April 2023, while the additional rate of 45% tax on earnings over ￡150,000 was also scrapped. April’s 1.25% rise in the rise in NI contributions is to be reversed and the cap limiting bankers’ bonuses will also be scrapped. The planned rise in corporation tax from 19% to 25% is also to be scrapped and there will be no stamp duty on the first ￡250,000 of a house’s value.

The government's phrasing of the budget as a 'financial statement' meant that the standard due-diligence normally performed by the OBR was not done, and hence many analysts are having to resort to their own assessments of what Friday's announcement will mean for the UK finances.

Cost of UK Borrowing Surges with 10-year now 112bpts above Ireland’s:

Bond markets have acted unfavourably to the new executive’s plans, with Friday seeing the greatest intra-day surge in gilt yields for decades with this trend continuing during today’s open. This morning, two-year gilt yields surged by 37bpts at the start of trading, to 4.365%, representing the highest level since September 2008 and being double the level of mid-August. Meanwhile five-year gilt yields have risen 32bpts 4.38%, while the benchmark 10-year gilt yield rose to 4.08% at the opening of the session having risen 25bpts. This is the highest level that it’s been since April 2010 and stands against a benchmark of the German 10-year Bund of 2.03%, while the US is at 3.76%.

This means that the UK 10-year yield is currently well above Ireland (2.69%), Spain (3.18%) and Austria’s (2.64%), while still remaining lower than Greece (4.6%) and Italy’s (4.4%).

With the cost of borrowing surging, the treasury will no doubt be assessing the impact of the largest level of tax cuts seen since 1972. One slight saving grace is that since most of the UK’s public debt is denominated in GBP, the overall foreign-exchange risk of the UK’s sovereign debt is minimal. Nevertheless, just last week we learnt that the UK is borrowing almost twice as much as expected in August as the cost of financing the UK’s ￡2.4tn debt continues to surge.

Energy Update:

In the oil markets, WTI crude futures are currently trading around $78dpb having fallen over ? a percent this morning. This comes as fears mount over the prospect of global economic downturn and investors speculate over a future slump in demand. Prospects over a resumption of the 2015 Iranian nuclear deal also appear to have decreased, adding upward pressure on oil prices, though OPEC remain below production targets. Concerning gas prices, TTF futures are currently trading at around €170 per megawatt hour – down around 37% on the month but up 123% on the year.