British government bonds sold out sharply and sterling hit a new 37-year low against the dollar as investors braced for a flood of debt sales to fund Treasury Secretary Kwasi Quarting’s tax cuts and energy subsidies.
The yield on the 10-year Treasury rose more than 0.2 percentage point on Friday to 3.7 percent, taking its rise for the week to more than half a percentage point. It represents one of the largest recorded increases in long-term borrowing costs. The British pound fell below $1.11 for the first time since 1985.
The massive sell-off in gold bonds and sterling on Friday came after Kwarteng said the government would scrap the top income tax rate of 45 pence, replacing it with a rate of 40 pence. He also announced a reduction in stamp duty on home sales.
The tax cuts, which will reduce government income, come as the UK is expected to spend £150 billion on subsidizing energy costs for consumers and businesses. Kwarteng said the energy bailout would cost £60 billion in the first six months.
Much of this borrowing will have to be financed by the sale of gold bonds. The UK Debt Management Office increased bond sales scheduled for the 2022-23 financial year by £62.4 billion to £193.9 billion.
“This is an escalation of the massive sell-off that we have already seen in the gold market over the past couple of months,” said Antoine Buffett, fixed income analyst at ING. “There’s a lot of tax cuts coming on top of the energy price guarantee, and that’s terrifying staggering investors who are now seeing more releases to come.”
Buffett said markets are also expecting sharper rate hikes from the Bank of England to offset the inflationary impact of Carting’s stimulus measures, after a 0.5 percentage point increase in the bank rate this week. Expectations of a Bank of England rate hike have pushed the 2-year bond yields up by more than 0.8 percentage points this week.
After the chancellor’s announcement, markets were pricing in gains of 0.75 percentage points at each of the next three BoE meetings, and raised interest rates to 4.5 percent.
The prospect of sharply raising interest rates did little to support the pound, which sank to a 37-year low against the dollar on Friday. Sterling fell as much as 1.6 percent after Kwarteng spoke, and reached as low as $1.1078, a level last seen in 1985, according to Refinitiv data.
The decline came as the dollar continued to rise against currencies around the world, two days after the Federal Reserve interest rate hiked by 0.75 percentage points for the third consecutive meeting in an attempt to tame soaring inflation. Against the euro, the pound fell 0.6 percent.
“In this kind of environment with a cost of living crisis, an energy crisis. . . “The chance of policy errors is increasing,” said Stephen Gallo, head of European forex at BMO Capital Markets. “The currency is going to show a lot of burden and it’s doing that now.”