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What you need to know about the collapse in sterling

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UK Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng during a visit to Berkeley Modular in Northfleet Kent, to coincide with the Government's new Growth Plan. Picture date: Friday September 23, 2022.

UK Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng during a visit to Berkeley Modular in Northfleet Kent, to coincide with the Government's new Growth Plan. Picture date: Friday September 23, 2022.

UK Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng during a visit to Berkeley Modular in Northfleet Kent, to coincide with the Government's new Growth Plan. Picture date: Friday September 23, 2022.

The pound plunged to an all-time low against the US dollar overnight as traders in Asia digested the UK’s “mini-budget” announced by new chancellor Kwasi Kwarteng on Friday.

Why is sterling suddenly in such terrible shape?

Sterling dropped as low as $1.04 before recovering somewhat through the morning, but with dollar parity potentially in sight, there is now a real sense of panic about the weakness of the British economy.

Kwarteng’s Growth Plan 2022 is dead on arrival, as far as markets are concerned. The strategy, which promises tax relief for the rich, lavish spending on energy subsidies and cuts in social welfare, has drained market confidence in the UK’s ability to navigate the economic challenges facing the country.

How bad is it?

The fear is that the new government’s policies will send inflation and government debt soaring, putting the economy into a kind of death spiral with a declining standard of living and a diminished capacity to generate growth.

The situation has become so grave so quickly that some commentators are contemplating the arrival on British shores of the International Monetary Fund (IMF) if new prime minister Liz Truss doesn’t change course.

Analysts at Bank of America have called her economic plans “toxic” and warned that the British currency is facing an “existential crisis”.

What does this mean for shopping or doing business the UK?

For shoppers, there is an obvious benefit to sterling’s weakness, especially now that it has started to bleed into the euro exchange rate in recent days.

Given that one element of the mini-budget was a Vat-free shopping scheme for goods bought in Britain, there are likely to be some significant bargains available, especially on big ticket items.

But even cross-border shoppers have something to gain, even though Northern Ireland has been left out of the Vat scheme. With euros worth relatively more, the effective price of goods bought in the North has come down.

For many businesses, however, it’s a different story. Exporters to the UK will be eating big losses unless they can increase prices, as income in sterling is falling in value.

On current trends, goods sent today will earn less when they arrive later in the week – and be worth even less when they are paid for in a month.

Did anyone see this coming?

Ironically enough, former chancellor Rishi Sunak – who lost the Tory leadership contest to Liz Truss just a few weeks ago – warned that if her policies were enacted it would lead to a collapse of confidence in the UK economy. By the end of September, he said, the IMF would have to rescue Britain from a self-inflicted economic disaster.

Immediate reaction to last week’s mini-budget was less apocalyptic, but no more favourable.

To take one vivid example, Harvard economist and former Obama adviser Larry Summers told Bloomberg that the UK was “behaving like an emerging market turning into a submerging market” and that the pound would fall below $1.

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Indeed, it’s hard to find anyone outside the Tory bubble who has anything good to say about what the Truss government has proposed.

What is going to happen now?

Assuming Truss and Kwarteng don’t immediately reverse course (Kwarteng has actually spoken about even more tax cuts on Monday), things could become grim indeed for the British economy.

Market pricing of gilts – UK government debt – indicate an expectation that interest rates are going to rise steeply.

That means the Bank of England is likely to be forced into a series of steep rate hikes for months to come. Some analysts are even forecasting an emergency rate hike to stop the slide in sterling and create some stability.

But that would be bad news for British businesses and consumers who are now going to see epic borrowing costs on top of inflation that is forecast to hit 11pc.

Essentially, the slow-motion car crash of Brexit may be taking its final tumble.


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