British pound plummets to near parity with U.S. dollar, before bouncing back

The British pound fell to its lowest level against the U.S. dollar since 1985 before bouncing back on Monday, as investors digest the U.K. government's plans to stimulate the economy by cutting taxes while borrowing more money to spend on programs.

Traders pushed the value of the U.K. pound down five per cent, just above $1.03 US, on Monday morning, the first trading dayafterChancellor of the Exchequer Kwasi Kwarteng the equivalent to Canada's finance minister unveiled the government's plans to boost economic growth this year.

In the face of sluggish growth and sky-high inflation, the governing Conservatives plan to slash corporate and personal income taxes to their lowest level in half a century, while also borrowing more money to subsidize food and energy prices for consumers.

"The Truss administration is rebooting the old Reaganomicsplaybook with large, unfunded personal/corporate tax cuts expected to drive supply-side investment and spur growth," said Bipan Rai, a foreign exchange analyst with CIBC.

The pound sold off heavily on the news, as traders expressed their doubts that the plan would work. Prior to Monday, the pound hadn't been priced this low in U.S. dollars sinceFeb.25, 1985, when it was going for about $1.05 and Margaret Thatcher was in power.

The early losses on Monday were mostly coming from trading in Asia. When trading in Europe began, the pound began to recover. By the afternoon local time in London, the pound was just barely positive on the day, after speculation grew that the Bank of England migh announce an emergency, unplanned rate hike.

In the end, that didn't happen as the central bank merely put out a statement sayingit "would not hesitate to change interest rates by as much as needed," which caused the pound to move down to about $1.06 US again.

The seesaw ride speaks to just how uncertain investors are in the British government's ability to rein in inflation without collapsing its already sluggish economy.

"The British have decided that going back to the 1980s on steroids is the best way to go, and clearly the market is just saying, 'That's not going to work,'" said Rabobank strategist Michael Every.

"The market is now treating the U.K. as if it's an emerging market. And they're not wrong in terms of the policy response and the naivety of thinking that boosting demand rather than supply is how you deal with a supply-side shock."

Strong chance of a further drop

Despite Monday's up-and-down ride, experts suggest the pound could well go lower still.

"Loose fiscal policy during a period of high inflation means that [the pound]will have to revalue lower," Rai said.

The sell-off in the pound is increasing the likelihood that the Bank of England will have to raise interest rates even more aggressively than it has been, to staunch the bleeding. Traders are expecting an unprecedented 125-point hike when the Bank of England meets in early November.

The yield on two-year government debt priced in pounds a bond known as a gilt jumped by its highest level in a decade on Friday, before beating that record on Monday. Two-year British gilts are yielding more than 4.5 per cent on Monday.

A year ago, that same government debt was yielding less than 0.5 per cent.

Anything priced in pounds is sinking like a stone for many valid reasons, but the strength of the U.S. dollar certainly isn't helping. As it often does during times of economic uncertainty, the U.S. dollar is strengthening as foreign investors flock to its perceived safety.

The loonie is trading at 73 cents US on Monday morning, its lowest level since 2020.