The plummeting value of the pound has sent the interest rate on government debts to a 12-year high, with money markets predicting the Bank of England base rate could almost treble to 6% next year.
Sterling tumbled to an all-time low of $1.03 against the dollar overnight before recovering to $1.07 in morning trading as traders priced in forecasts of a major intervention from Threadneedle Street to support the currency.
Traders expect the central bank to convene a meeting of its monetary policy committee (MPC) soon to raise interest rates from 2.25% to 3% before increasing them further at a scheduled meeting in November.
It was understood that officials spent much of Monday morning preparing a statement for the markets after No 10 spokesperson ruled out any comment on the situation by the government.
A statement was expected in late afternoon in the event of further falls in sterling, to send a message to investors that the Bank would use all its powers to bring inflation under control and down to its 2% target.
One analyst described sterling’s situation as “toxic”, while another said investors had digested the implications of Friday’s mini-budget, which stacked a further £45bn of unfunded tax cuts on top of an estimated £150bn bill for its energy price bailout scheme, and “seemed inclined to regard the UK Conservative party as a doomsday cult”.
A further rout of the British currency could take it below parity with the dollar and into uncharted territory on international exchanges.
It is understood the MPC, chaired by the Bank’s governor, Andrew Bailey, will be reluctant to intervene when the defence of the currency is not among its responsibilities, instead focusing on its target of bringing down inflation to 2% over the next two to three years, from 9.9% in August.
However, several MPC members have highlighted the fact that a drop in the value of the pound can fuel inflation via the higher cost of imported goods and raw materials.
A rise in interest rates, if it shores up the value of sterling, could limit the pressure on inflation, though traders may interpret an emergency rise as a signal of panic at the Bank, prompting further selling.
Adding to concerns about the government’s grip on economic policy, the cost of financing UK debts doubled on international bond markets. The interest rate on five-year government bonds raced to 4.5% from 2% last month and just 0.5% a year ago.
Analysts at Bank of America Merrill Lynch said the “trickle-down economics” theory behind the mini-budget was flawed. “Empirical evidence suggests tax cuts of this type have an inconclusive effect on potential growth.” They said the cost amounted to 1.5% of GDP but would only boost growth by 0.2%.
In response to disquiet among Tory MPs at the reaction of financial markets, the analysts added: “The policy backdrop is toxic and is pushing [the pound] towards an existential crisis.”
Samuel Tombs, chief UK economist at consultancy Pantheon Macroeconomics, said markets were pricing in a 0.75 percentage point increase in the central bank’s base rate before the end of the week.
The pound recovered weekend losses after traders speculated that the MPC would intervene, he said. “Sterling will weaken further if Governor Bailey doesn’t act,” he said.
Paul Dales, chief UK economist at Capital Economics, said Bailey could come out with “tough talk” supported by a large and immediate interest rate hike. “That could involve something like a [one or 1.5 percentage point] hike in interest rates (to 3.25% or 3.75%), perhaps as soon as this morning,” Dales said
The shadow chancellor, Rachel Reeves, told Times Radio she was “incredibly worried” by the market reaction to the mini-budget.
The former MPC member Martin Weale said markets were “frightened” by unfunded tax cuts being pumped into the economy at a time of high inflation. “It is hard to see this policy [of tax cuts] ending happily.”
Weale added: “I expect sterling will continue falling this week, and if it does the Bank of England may need to step in with even higher interest rates.”
The Kings College London economics professor played down fears of an emergency meeting of the MPC, but warned its base interest rates may head towards 4% or 5%, pushing mortgage rates above 7%.
Nick Macpherson, a former permanent secretary at the Treasury, said he was concerned that his successor, Tom Scholar, a veteran of the 2008 financial crash, was sacked by the chancellor, Kwasi Kwarteng, before the mini budget.
“To fire your only official with serious experience of crisis management and then precipitate a crisis a fortnight later brings postmodernism to a new level,” he said.
