The UK pound plunged to an all-time low on Monday, hit by the impact of the fiscal measures rolled out by the new government. The full-blown sterling crisis set off expectations of an emergency rate hike by the Bank of England.
The pound dropped to just $1.0327 against the greenback on Monday morning, below the 1985 baseline of $1.0545. The sharp plunge in the sterling was triggered by the tax cutting measures announced by Chancellor Kwasi Kwarteng.
Pound Claws Back
The Sterling's loss in the morning triggered fears of it reaching parity with the US dollar but during the day the British currency clawed back to $1.0931. However, this appreciation was fueled by market expectations of an emergency rate hike by the Bank of England.
The pound tumbled on Monday as the financial markets were spooked by the extraordinary budget measures announced by the new Chancellor, which would worsen inflation.
Political Challenge for Truss
"It would be foolish to rule out parity ... If the market's got the bit between its teeth, then fair value, or valuations or fundamentals are going to count for very little," said Dean Turner, UK economist at UBS Private Banking, according to Bloomberg.
Such a scenario will pose a big political challenge to the new Prime Minister, Liz Truss. The new Tory government had pledged to roll out generous tax cuts, and Kwarteng has kept his promise. But with the sterling going down, the Labour has accused the government of taking UK through the highway to hell.
However, Kwarteng has not given any indication that he will change the policy. Instead, there have been comments that indicated that more tax cuts are in the offing.
Focus on BoE
This has turned the limelight on the Bank of England. Analyst expect that the BoE would go for an emergency rate hike to stem the sterling rout. While most analysts expect the rate hike to be of 50 basis points, some do not rule out even a 100 basis point rate hike.
According to economist Dan Hanson, the BOE could raise its benchmark by 100 basis points as the central bank will be alarmed if the currency drop is sustained.