Why Is The British Pound Falling Today?

The pound sterling plunged on Monday to a historically low level against the dollar because investors are worried about London's new budget spending.

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The pound sterling plunged on Monday to a historically low level against the dollar because investors are worried about London's new budget spending.

Financial markets
Historic fall in the pound sterling in the United Kingdom: "Wealous circles are settling in and participating in investor mistrust"

The pound sterling plunged to a historically low level against the dollar on Monday because investors are worried about new London budget spending. Decryption with economist Jézabel Couppey-Soubeyran.

Big dislump for the pound sterling. The United Kingdom's currency plunged this Monday, reaching $1.350 overnight: its historic lowest level, which dates back to 1985 when it reached 1,0520. Around 11 a.m., the British currency remained down 0.88% but had risen to $1.763.

How to explain this new fall in the pound against the dollar?

The new government of Liz Truss [the Conservative Prime Minister of the United Kingdom since September 6, editor's note] announced on Friday fairly important support measures for households and businesses, without explaining how they would be financed.

On the contrary, Liz Truss makes them coexist with tax reductions for companies. This means that to finance these measures, the United Kingdom will be forced to go into even more debt on the markets. Markets thus expect a deterioration in the debt ratio to gross domestic product (GDP).

However, central banks are tightening their monetary policies and ending asset purchases. So investors know that the public debt securities they buy can lose a lot of value on the markets.

Thus, they are again in a performance/risk arbitration. The securities that represent the most risks must be those that earn the most return on them. In this context, the return/risk analysis of the United Kingdom's public debt instrument is quite unfavourable.

Very concretely, it pays less and presents more risk than an American treasure voucher. Consequence: investors prefer US debt to British debt. They sell British debt securities and this self-realizes what they feared: the value of the securities is falling.

What can be the consequences of this plunge for the British and their economy?

As investors flee sterling sterling investments, the British currency is falling on the foreign exchange market.

And as the pound sterling declines on the foreign exchange market, imported inflation [when the exchange rate of a currency depreciates against the dollar, the cost of imported products increases] in the United Kingdom also strengthens.

So all bills to be paid in foreign currencies are increasing, including gas, oil and fossil fuel bills on which the United Kingdom is still quite dependent. Vicious circles are settling in and participating in the mistrust of investors.

The fall of the pound sterling is thus likely to strengthen British inflation, which is linked to structural and profound factors: energy dependence, the slowness of the ecological transition. When the exchange rate of the currency decreases, fossil fuel bills become more expensive and this helps to "import" inflation.

Liz Truss' announcements are ambivalent: on the one hand, she says she will protect British households from inflation related to energy problems but on the other, she seems to question the ecological transition when these are the deep factors of current inflation. In doing so, inflation will probably continue to rise, which may increase investor mistrust.

What are the levers available to the United Kingdom?

To try to limit the decline in the pound sterling, the Bank of England (BoE) will probably intervene in the foreign exchange market as the Bank of Japan (BoJ) did recently. It's not in her missions but she can do it from time to time, when necessary. The next meeting will take place in early November.

The United Kingdom's central bank will probably meet before to also decide on an increase in the key interest rate to close the gap with the United States, so that longer-term rates rise and investors return to the British market.

The United Kingdom can also be expected to use "financial deregulation" to retain investors or bring them back to its territory.

At the moment, their communication operation is a little scary to those interested in financial stability. To attract investors to the British market, they are explaining to us that they will remove the bankers' bonus ceiling and probably embark on a major financial deregulation operation. This promises significant shocks in the financial markets.