UK pound sterling falls to 37-year low

The pound sterling dropped by 2% to as low as $1.1042 — the currency's weakest since early 1985 — on Friday, as the UK government announced historic tax cuts and hefty increases in borrowing.

With sterling already suffering from the effects of rampant inflation, the aftermath of the COVID pandemic and Brexit, some traders have also eyed the government's plans nervously.

Why is the pound faring badly?

Traders appear increasingly anxious about the UK's economic outlook, with runaway inflation caused by Russia's war in Ukraine posing a threat to economies around the world.

Soaring inflation and a cost-of-living crisis pose an immediate challenge to the government of newly installed UK Prime Minister Liz Truss.

Inflation is running at nearly 9.9%, the highest level since the 1980s — and it is predicted to rise to 11% next month.

The pound slipped against the euro — itself trading poorly on currency markets — on Friday morning, dropping from €1.14 to €1.13.

Sterling's drop against both currencies came a day after the Bank of England hiked interest rates by 50 basis points. While such an increase would typically drive up the currency value, it comes as many other central banks are doing the same.

As it raised rates, the bank announced that the UK may already be in recession, defined as two successive quarters of economic contraction. There are fears that higher interest rates could stifle investment as the cost of borrowing rises.

Meanwhile, some investors are wary of the Truss government's readiness to fund growth and tax cuts by borrowing.

What is the UK government doing?

UK Treasury chief Kwasi Kwarteng laid out a series of tax cuts aimed at boosting growth, saying it would be funded by borrowing and an increase in revenues through increased growth.

Kwarteng said the government would cut personal income tax, scrap a planned business tax rise and lift a cap on bankers' bonuses in an effort to revive the faltering economy.

The basic rate of income tax will fall from 20% to 19% next year, while the top rate will shift from 45% to 40%.

Kwarteng's announcements were tagged as a "fiscal event" rather than an actual budget because it was not accompanied by an assessment from the independent Office for Budget Responsibility.

The opposition Labour Party has described the plans as a "desperate gamble."

"Never has a government borrowed so much and explained so little... this is no way to build confidence, this is no way to build economic growth," said Rachel Reeves, Labour's finance spokeswoman.

The UK's leading economic research body, the Institute for Fiscal Studies, said the slashing of taxes was the largest since the 1972 budget. Those cuts are widely regarded to have had negative repercussions by fueling inflation.

rc/wmr (AFP, dpa, Reuters, AP)