One of the most pronounced market sell-offs in recent history took place after the first fiscal policy announcement from the new British Prime Minister.
The British pound fell to an all-time low against the dollar in the early hours of Monday morning.
The pound shouldn't be seen as a strength of the dollar, according to Jim O'Neill.
He said that it was a consequence of an extremely risky budget by the new chancellor and a timid Bank of England.
The announcement Friday featured a number of tax cuts not seen in Britain since 1972, as well as a return to the Keynesian economics promoted by the likes of Ronald Reagan and Margaret Thatcher. With sky-high inflation and a cost-of-living crisis, the U.K. is at odds with most major global economies.
The fiscal package, which includes around £45 billion in tax cuts and £60 billion in energy support to households and businesses over the next six months, will be funded by borrowing at a time when the Bank of England plans to sell £80 billion in gilts.
The market believes that the Bank will need to raise interest rates more aggressively in order to control inflation. The yield on 10-year gilts has risen 131 basis points so far in September, and is on course for its biggest monthly rise since 1957.
The focus of the government is to boost growth through tax and regulatory reform, with the new finance minister suggesting in an interview on Sunday that more tax cuts could be on the horizon. Critics say the plan disproportionately benefits those with the highest incomes.
The Institute for Fiscal Studies accused Kwarteng of pushing through huge tax cuts without even a semblance of an effort to make public finance numbers add up.
Sky News reported on Monday that some Conservative Members of Parliament are writing letters of no confidence in the new prime minister because they fear she will wreck the economy.
Vasileios Gkionakis, head of European FX strategy at Citi, told CNBC on Monday that the massive fiscal stimuli and tax cuts, financed by borrowing at a time when the Bank of England is embarking on quantitative tightening, is indicative of an "erosion of confidence" in the
He said there was no empirical evidence to support the government's claim that expanding fiscal policy will drive economic growth.
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"For it to provide at least a meaningful temporary relief, it would have to be big, so my best guess is that it would have to be at least 100 basis points of a hike."
Another 100 basis points is going to cause the economy to go into a tailspin, and eventually is going to be negative for the exchange rate, so we are in this situation right now.
Analysts said on Monday that they expected the Bank of England to accelerate its monetary policy tightening.
Roukaya Ibrahim, vice president at BCA Research, said in a research note Monday that the fiscal development implies that the BoE will need to tighten policy more aggressively than it would have otherwise.
The pound's selloff highlights that market participants are skeptical that foreign investors will be willing to fund the deficit amid a poor domestic economic backdrop.
The U.K. financial markets would suffer further due to the unfavorable policy mix.
The scale of tax cuts and lack of offsetting revenue or spending measures raised concerns about the country's fiscal strategy and policy mix.
The British lender expects the government to clarify its plans to balance the books through "spending cuts and reform outcomes" ahead of the November budget statement.
The government is expected to launch an energy saving campaign over the next few weeks.
Fiscal and energy saving should help to contain domestic and external imbalances.
In the context of supply impairments, a tight labor market and almost double-digit inflation, even the smallest positive demand shock may cause huge inflationary consequences.
He said that this could cause the Bank of England to raise interest rates by 75 basis points in November.
While the U.K.'s trade performance may be bleak, the fact that the country borrows domestically and invests abroad means its external position improves.
Fiscalsustainability metrics are not different from peers even though public debt is large. The risks of a balance of payment crisis should be mitigated by that.
The U.K.'s economic fundamentals do not call for a sharper hike than the bank's new baseline expectations of 75 and 50 basis points at the next two meetings.
We don't think the government will reverse course at this point. Rather, as mentioned above, we expect it to pull forward by speeding up structural reforms and the spending review.
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