Pound falls on new UK government support package
The pound sterling has been in crisis since Friday, falling more than 5% against the dollar in less than two days following new budgetary measures presented by the British government.
New Prime Minister Liz Truss has announced the biggest round of tax cuts since 1972 and massive energy bill relief, valued by economists at more than £100billion, to spur stronger economic growth, but raising fears of higher inflation for longer.
The foreign exchange market reacted to this imbalance in the current balance of payments by abandoning the pound sterling. The GBP/USD thus returned to touch its historic low recorded in 1985 at $1.0345 this morning. To stabilize the exchange rate, demand for other imports must decline, usually as a result of a combination of tighter monetary policies and a falling exchange rate.
The ability to stop the decline of the pound sterling is under the control of the Bank of England. The question is whether the BoE is ready to make tough choices to support the pound in the short term (much higher policy rates) and slow consumption so that imports align with exports.
The magnitude of the rate hikes that would be required to significantly alter the attractiveness of sterling would be unacceptable to economic agents in the country, so it is likely that the BoE will accommodate a larger cut foreign exchange rates.
H2: GBP/USD monthly price chart – key levels