Following the announcement of sweeping tax cuts for the wealthy from the United Kingdom's finance minister, the British pound has hit a record-low in trading against the U.S. dollar. The Bank of England, the U.K.'s central bank, also recently reported that the country's economy had entered a recession.
The pound dipped to $1.03 before rebounding slightly to $1.07, still the lowest level in four decades.
In Parliament last week, Exchequer Chancellor Kwasi Kwarteng, the U.K.'s treasury chief, introduced plans for the largest tax cuts seen in the country in fifty years, along with plans to increase government borrowing to cover the cost of public spending. Kwarteng says that the missing revenue from the cut taxes will be made up for by a stimulated economy.
Citibank called the tax cuts a "huge, unfunded gamble for the U.K. economy," and Kwarteng's plan is expected to work in direct opposition to efforts from the central bank to keep inflation at around 2%. It's rare for finance directors and central banks to work in conflict with one another, and these actions from the Conservative British government have received swift push back from the Labour Party as well as other Conservatives.
"Trickle-down economics isn't the answer," Labour's finance spokesperson, Rachel Reeves said on Twitter
With so much tax revenue from the U.K.'s highest earners and businesses being lost, investors expect the country to turn to international lenders to cover the shortfall. As borrowing increases, the risk of lending to Britain will also increase, raising interest rates for the country. Some worry that investors may "punish" the U.K. for its reckless financial decisions by driving up the cost of U.K. bonds which are already at multi-year highs.
Along with worsening debt, investors are also worried about inflation in the U.K. Inflation is nearing double digits, and lower taxes could lead to higher spending and even more inflation. A weaker pound also means even higher prices on imports which are typically dependant upon overseas currencies. For instance, all oil and gas imports to the U.K. are paid for in dollars.
Many U.K. businesses also rely on imports to function, meaning higher prices on domestic products, as well.
In order to keep inflation in check, the Bank of England may eventually need to raise interest rates, something that could hurt the country in the long term. As interest rates rise, the pound may see a bump in value, but the negative effects could counteract any progress. Higher interest rates would squeeze the British housing market and could discourage borrowing that would otherwise contribute to the economy.
"The Bank of England has to be the counter to what the government is doing," said Susannah Streeter, senior investment and markets analyst at financial services company Hargreaves Lansdown. "They're in an economic tug of war, with the Bank of England trying to dampen down demand in the economy and the government trying to increase demand in the economy."
It's important to note that the pound's current position isn't all the U.K.'s fault. While the pound has been weakening, the U.S. dollar has been growing in value, pushing down other currencies virtually across the board.
