Pound falls to 14 month low as bond sell off pressures Reeves

The pound briefly fell to a 14-month low against the US dollar on Thursday morning after a sell-off in the bond market heightened investor concerns about UK assets and added further pressure on the Chancellor, Rachel Reeves.

Sterling continued its recent decline, losing a cent at one point, before recovering slightly, ending the day down half a cent at $1.23. The sell-off in UK government bonds, known as gilts, caused a rise in the yield, or the interest rate, paid to bondholders, consequently pushing up the country’s borrowing costs.

However, comments made by the chief secretary to the Treasury, Darren Jones, later in the day seemed to ease market concerns. He assured the House of Commons that “gilt markets continue to function in an orderly way,” implying that emergency measures were not necessary. Following his statement, yields began to drop, reversing some of the earlier increases.

Jones further emphasized that underlying demand for the UK’s debt remained strong, supported by a diverse investor base. His statement provided more reassurance compared to Reeves’ public attempt to stabilize the situation the previous evening, where she declared that she maintained an “iron grip” on the public finances.

Despite this, bond yields remained elevated. The benchmark 10-year UK debt yield increased by as much as 0.12 percentage points to 4.921%, its highest level since 2008, before easing back. Thirty-year bond yields also surged to 26-year highs earlier this week, though they too later returned to a more stable position.

Michael Brown, a senior research strategist at Pepperstone, stated that the situation appeared to be worsening in the UK. He noted that the combination of rising bond yields and a falling currency indicated a loss of investor confidence in the government’s ability to manage the fiscal situation.

Brown remarked that while the current scenario had not reached the crisis level seen under former Prime Minister Liz Truss and Chancellor Kwasi Kwarteng in 2022, it suggested that economic stability was now precarious. Increased borrowing costs could limit Reeves’ ability to navigate the public finances and might force her to announce further austerity measures.

Investment manager Matthew Amis from abrdn predicted that Reeves would likely breach her newly established fiscal rules when the Office for Budget Responsibility presents its updated forecasts at the end of March. This could lead to significant cuts in government spending.

Global markets were also affected by the sell-off in UK gilts. Chris Turner, global head of markets at ING, explained that the global bond market’s turmoil had a direct impact on the gilt market, causing investors to scale back their positions in sterling. While some investors had previously favored sterling as a hedge against a strong US dollar, the bond sell-off has caused them to reassess their optimism toward the pound.

Despite recent losses, the pound remains significantly above its record low following the 2022 mini-budget, which saw it drop to near parity with the dollar.

Former Bank of England policymaker Martin Weale drew comparisons with the 1976 financial crisis, when the UK had to seek a bailout from the International Monetary Fund (IMF). Weale suggested that the current situation could lead to a similar crisis if the combination of a depreciating pound and rising long-term interest rates continued to worsen.

The Conservative party and the Liberal Democrats have urged Reeves not to go ahead with her scheduled visit to China to drum up international investment, given the current economic challenges. Liberal Democrat leader Ed Davey called for an emergency fiscal statement, including the cancellation of the national insurance hike scheduled for April, to provide immediate relief to the UK economy.

A recent survey by the Bank of England revealed that over half of UK businesses plan to raise prices or cut jobs in response to the increase in employers’ national insurance contributions (NICs) set for April. The survey also indicated that many companies would lower profit margins or reduce wages due to the added financial burden of the NIC hike.

This evolving situation underlines the significant pressure facing the UK economy and the government’s financial strategy, particularly as bond markets remain volatile and investor confidence in sterling fluctuates.