Last week, the Bank of England announced an increase in the base interest rate of 0.5% following Thursday’s Monetary Policy Committee (MPC) meeting. The level of the rise had been expected by most economists, although some had even predicted a more significant increase of 0.75%. The hike has taken the base rate to 2.25%, its highest level in 14 years.
The day after the MPC meeting, the new chancellor under the Truss administration, Kwasi Kwarteng, announced a range of tax cuts as part of a “mini-budget,” termed a “fiscal event” by the government. However, this move sent financial markets into meltdown and resulted in the pound falling to a 37-year low against the dollar. This has led to calls for intervention from the Bank of England, with some claiming that emergency interest rate hikes may be required.
Markets reacting badly
According to reports, the markets were already reacting badly before the announcements of tax cuts by the chancellor. The pound fell by over 3% against the dollar by 9.00 am and dropped by more than 1% against the euro. This brought the pound against the dollar to below $1.09 and against the euro to €1.12. On Monday, 26th September, the pound slid further to a record low of $1.03. There is now speculation the Bank of England could intervene this week.
Officials from several international financial institutions claim that sterling is facing a confidence crisis. Citi financial experts even stated that, for the first time, the pound could fall level with the dollar.
Some investors believe the Bank of England will have to increase the base rate by 1% next month. This has resulted in financial markets predicting that the base rate will hit 5.5% by the end of the year compared to the previous prediction of 4.75%.
Following the mini-budget and the plunging pound, another leading financial institution, Deutsche Bank, called for intervention from the central bank. Officials from the bank suggested that the Bank of England call a one-off MPC meeting with a view to an emergency rate hike to prop up the pound.
George Saravelos, an analyst at Deutsche Bank, said: “Both the pound and gilts are experiencing historical drops. The market is giving very strong signals it is no deficit position at the current configuration of UK real yields and exchange rate. The policy response required to what is going on is clear: a large, inter-meeting rate hike from the Bank of England as soon as next week to regain credibility with the market.”
Larry Summers, a former secretary at the US Treasury and now an economics professor at Harvard, said that the new government’s policies could result in the pound falling below parity with the dollar. He said this was down to a combination of Brexit and new fiscal policies. Summers said: “It would not surprise me if the pound eventually gets below a dollar. This is simply not a moment for the kind of naive, wishful thinking, supply-side economics that is being pursued in Britain.”