The Daily Telegraph
Sterling at lowest level since 1985
♦ Markets fear Bank of England Governor lacks commitment to tackling inflation ♦ Chancellor tells business leaders he will press ahead with ‘Big Bang 2’ deregulation ♦ Treasury ministers seek new power to overrule watchdogs to slash red tape
THE pound sank to its lowest level since 1985 amid concern about the Bank of England’s commitment to fighting inflation and Liz Truss’s plans for a borrowing spree.
Sterling fell by as much as 1pc to $1.1410 yesterday, the lowest since 1985, just before major economies signed the Plaza Accord to weaken a surging dollar under Ronald Reagan.
The drop came amid concerns Bank officials will slow efforts to fight inflation as Liz Truss prepares a massive support package that will cut energy bills.
Meanwhile Kwasi Kwarteng, the new Chancellor, told City leaders he intends to forge ahead with a wave of deregulation dubbed “Big Bang 2”. Treasury ministers also confirmed plans for a new power allowing them to overrule watchdogs that impose unnecessary red tape.
Andrew Bailey, the Governor of the Bank of England, told MPS on the Treasury select committee that he was very concerned that inflation – which stands at 10.1pc – would lead to a prolonged period of higher prices and wages.
But Huw Pill, the Bank’s chief economist, appeared to dampen hopes of steep interest rate rises when he said the Prime Minister’s expected £2,500 annual price cap would “lower headline inflation”.
Mr Kwarteng said he would meet Mr Bailey weekly to “coordinate closely to support the economy” as he described the Bank’s independence as “sacrosanct”.
However, the Chancellor is also set to be granted ultimate control over financial regulation, with a controversial “intervention power” in the Financial Services and Markets Bill allowing the Government to override the decisions of the Bank and other regulators if they threaten to hold up reform.
Richard Fuller, the City minister, confirmed yesterday that a version of what was previously dubbed a “call-in power” will be added to the Bill going through Parliament. He said ministers would use the power to “make, amend or revoke rules if in public interest”.
The introduction of such a power has been heavily resisted by regulators, with Mr Bailey expressing concern.
Analysts at Goldman Sachs even warned of “potential personnel changes” at the Bank, suggesting that Mr Bailey’s eight-year term could be halved in a potential review this autumn. This would mean a new governor in March 2024. Sources in Threadneedle Street and the Government dismissed the idea.
The Bank of England, which has raised rates six times in a row to 1.75pc, has come under fire alongside other central banks for failing to get a grip on inflation. “They’re all a day late, and a dollar short,” said one senior banker after Mr Kwarteng held a meeting with industry bosses. Analysts said the drop in the pound was also due to the UK’S dire growth outlook.
Mr Bailey told the Treasury select committee that the Bank would keep an intention to start selling its stockpile of UK government debt “under close con- sideration”, following a big jump in UK borrowing costs last month and the prospect of another borrowing binge to fund energy subsidies.
Mr Pill said the Bank could use interest rates to boost the economy in the event that the sales rocked markets.
Meanwhile, in a meeting with senior City leaders, Mr Kwarteng said the Government would unleash a “Big Bang 2” and will pursue sweeping financial reforms to unleash growth and competitiveness on a scale not seen since Margaret Thatcher’s reforms in the 1980s.
Areas that are likely to be targeted include the controversial Solvency II rulebook that forces insurers to hold vast sums of cash on their balance sheets, blocking investment, and Mifid 2, regulation around financial research that was intended to reduce conflicts of interest but is widely felt to have harmed capital markets. Both rulebooks were part of a European Unionwide regime from before Brexit.
One executive at the meeting said their “overwhelming impression” was that Mr Kwarteng was focused on “shortterm delivery” and “short-term wins”. Reiterating a commitment to target annual growth of 2.5pc, Mr Kwarteng said: “The Prime Minister and I are committed to taking decisive action to help the British people now, while pursuing an unashamedly pro-growth agenda.”
The Treasury added that the Government’s energy bailout plans will require “higher borrowing in the short term whilst ensuring monetary stability and fiscal discipline over the medium term”.
The meeting was attended by senior figures including the chief executives of Natwest, HSBC, Barclays and Lloyds, as well as the bosses of the London Stock Exchange and the insurers Legal & General and Aviva. It is understood that Mr Kwarteng will today also meet Jamie Dimon, the chief executive of JP Morgan, who is visiting London.
For my vintage, 1976 is synonymous with a long hot summer. This year’s heatwave has provided endless opportunities for “you should have seen it when” stories. But the similarities between then and now don’t end with the weather. The economy and financial markets, too, look eerily familiar.
Double-digit inflation, an energy blockade, the pound under pressure, friendless bond and stock markets, soaring commodity prices. It really is déjà vu all over again. All we need to complete the set is Kwasi Kwarteng turning the ministerial car back at Heathrow to ask the IMF for a bailout.
That might sound ludicrous, but avoiding a humiliating run on the pound and the gilts market is Liz Truss’s second priority after today’s energy support package. The two, of course, are linked, because the credibility of her plan to address crippling heating bills this winter will determine whether she will be able to rely on the elusive kindness of strangers in the difficult months ahead.
A new leader’s first 100 days are traditionally seen as crucial to their subsequent political fortunes. But the new PM knows she doesn’t have that luxury. The wholly unnecessary two-month interregnum between Boris Johnson’s resignation and her meeting with the Queen on Tuesday wasted precious time.
The long summer policy vacuum gave investors the opportunity to fret about the public finances in a way that, ERM crisis aside, they haven’t had to for nearly 50 years. August was a shocker for both sterling and gilts. The yield on 10-year bonds rose during the month from 1.8pc to 3pc, a level not reached since the financial crisis. The pound, meanwhile, has fallen to its lowest level since the mid-1980s, down 4.5pc in August and 14pc year to date.
Shunning the UK Government’s debt was an understandable response during the leadership campaign. Markets were right to worry about the pre-campaign pretence that tax cuts could be the silver bullet to solve the energy bill crisis. And they are right to be just as concerned that the post-election solution will instead involve eye-watering dollops of taxpayers’ cash.
Capping energy prices is going to be seriously expensive. This is true whether they are presented candidly, as seems likely, as a further addition to government borrowings that are already close to 100pc of GDP, or somehow taken off the books. The amount of money involved is certain to be at least £100bn, and possibly significantly more if a viable means of targeting the support cannot be found before next winter. One way or another, the Government is going to have to issue twice as much debt as it hoped this year.
Perhaps it makes little difference whether the fiscal stimulus comes in the form of tax cuts or what the PM could dismiss as handouts before campaigning turned into the harder work of governing. In either case the result will be to add fuel to the inflationary fire. Either way, the unavoidable task of preventing an energy crisis from turning into a winter of widespread business failure and social unrest will make the Bank of England’s inflation-busting challenge even harder.
As Jim Callaghan noted in 1976 at the Labour Party conference: “We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists and that, insofar as it ever did exist, it only worked by injecting a bigger dose of inflation into the economy. Higher inflation, followed by higher unemployment.” Plus ça change.
Today the Government has two problems that it did not in 1976. The first is that it is heavily exposed to inflation-linked debts, and the cost of servicing these is self-evidently rising rapidly. The second problem that didn’t exist back then was a central bank putting into reverse an £850bn quantitative easing programme. Between them, the Bank of England and Treasury could be dropping a lot of gilts onto the market over the next year or two.
So, bond yields are likely headed higher and for longer. But it’s the combination of higher borrowing costs and a falling pound that’s the “worst nightmare”, as Lord Macpherson, former permanent secretary at the Treasury, has described it. The pound is already at a 30-year low but there are serious voices suggesting it could follow the euro to parity with the dollar. My family’s 2007 US holiday when the pound bought $2 is a dim and distant memory.
How low could the pound go? With a current account deficit approaching 10pc, a sudden slump is no longer inconceivable. Were the UK unable to attract enough foreign capital to fund the external balance, the pound would need to drop significantly to plug the gap. Just to bring the balance back to the 10-year average could require a 15pc depreciation. A hawkish Fed, with a still buoyant US economy providing cover for a prolonged monetary squeeze, can only worsen the outlook for sterling.
The outlier in all this is, of course, the UK stock market. That’s because the lion’s share of FTSE 100 revenues is earned overseas. The weak pound disguises the challenges British companies face by increasing the translated value of foreign earnings. This is why the UK benchmark has moved sideways this year even as the S&P 500 has fallen close to bear market territory.
The UK stock market has the added benefit of being heavily exposed to the areas of the market, notably energy and mining, that look well-placed for the current economic and market conditions. An awful lot of bad news is now priced into UK assets. At the end of this long hot summer, and with the Government rightly kicking the can down the road today, the sellers of UK shares, if not of gilts and the pound, are getting thinner on the ground.