The U.K.'s pound has hit its lowest-ever level against the U.S. dollar. Yet, investors expect the pound to continue to fall, going so far as to say that the pound may reach parity with the U.S. dollar - a historically unprecedented situation. In the background of this currency dilemma, is a host of surrounding issues: the death of Queen Elizabeth, further tax cuts proposed by Liz Truss, and talks of a recession. Naturally, these issues have compounded together to unnerve investors to take their pounds and invest in a traditional safe haven: the dollar.
There's no reason why the pound doesn't keep selling off. I see it deteriorating to the point where it could break below parity [with the dollar] before the year end" (WSJ, 2022).
Investors can be sure there is light at the end of the tunnel. Indeed, there is an inevitability that a steep discount will be available to investors on U.K. foreign assets. This is likely to attract capital inflows and serve to increase the price of the pound relative to the dollar. Yet, this situation is a distant future as the U.K. markets remain volatile and economic policy remains unorthodox.
Liz Truss' government will face increased government borrowing costs, however, given the time lag in said costs, the true damage will be realised in the coming weeks and months. The Bank of England (BOE) will have to continue to raise interest rates to draw investors back to the pound by fighting inflation which sits at 9%. Conversations of an emergency interest rate rise to tackle inflation are snowballing into a possible reality. If this were to happen, it would come less than a week after the Bank lifted interest rates to 2.25%. Not to mention the effect this has on households with mortgage costs who are already battling the cost of living.
More specifically, the pound continues to remain weak against the dollar which means oil and gas will be more expensive. Other imported goods will be considerably more expensive, further pushing up inflation. The Prime Minister and Chancellor have failed to comment on the state of the pound, causing investors to act under more fear and uncertainty.
"It looks like we're headed for a spiral that we usually see in emerging markets crises, where policymakers struggle to reassert credibility" (Chief Economist, Bank of Singapore)
If the government continues to rely on inaction, they are providing the public with perfect grounds to undermine its credibility. At a minimum, an indication by political actors of the government's would serve to restore a sense of certainty and credibility in them. How do you think this situation will play out?
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