The currency crisis impacts prices, investors and how the Bank of England manages interest rates.
The crisis was triggered by Chancellor Kwasi Kwarteng announcing sweeping tax cuts in his fiscal event – or disguised mini-Budget – a few days ago.
Table of contents
- What Is A Currency Crisis?
- What Does The Crisis Mean For Expats?
- What Caused The Crisis?
- What Should The Chancellor Do?
- How Does The World See The Crisis?
- What Action Is The Bank Of England Taking?
- What’s The Future For The Pound?
- What’s The Future For Liz Truss And Kwasi Kwarteng?
- Currency Crisis FAQ
- Related Information
He believes taking less tax will leave consumers with more money to spend, which in turn will stimulate growth in the economy.
But the markets disagree and consider the Chancellor’s unfunded actions ill-timed and irresponsible fiscal management.
Since then, the pound has plunged to a record low against the US dollar while suffering double-digit inflation, causing what was once a model economy and the sixth largest in the world to crash and burn.
In an effort to turn the country’s finances around, the Bank of England is buying up long-term gilts in a bid to reduce the interest the government must pay on borrowing.
Expats are as likely to feel the consequences as much as householders and businesses at home
But what is a currency crisis, and how does the state of the pound affect day-to-day living?
What Is A Currency Crisis?
A sharp fall in the value of a currency breeds confusion and doubt. Businesses that import or export goods are uncertain about how to price goods. If the pound drops in value, the price of imports goes up, while the cost of exports rises.
This uncertainty has already been seen as banks and building societies have withdrawn mortgage offers over concerns about what will happen to interest rates.
What Does The Crisis Mean For Expats?
The currency crisis impacts British expats in many ways, especially those with property and investments in the UK.
Expats paid the state pension overseas will find their cash does not buy as much – especially in the United States and countries with currencies linked to the dollar.
The values of homes and other investments are likely to fall, while the cost of British goods overseas will rise. The FTSE100 has sunk from 7237.64 to 6844.72 in the days since the Chancellor’s disastrous tax U-turn.
Cash in offshore accounts will buy less and cost more to convert into foreign currencies.
What Caused The Crisis?
Two standout reasons are at the root of the currency crisis.
First, the Chancellor’s decision to pay for huge tax cuts from government borrowing unnerved the markets. Investors worry that the anticipated £45 billion bill for tax cuts will over-burden the economy with hefty borrowing to meet interest payments for years to come.
Rather than aid growth, the concerns are that the debt will hold back economic expansion.
Second, the strength of the dollar undermines other currencies. The dollar has increased in value as the US Federal Reserve has aggressively hoisted rates, weakening the pound and other currencies.
What Should The Chancellor Do?
It’s clear economists around the world are against the UK tax policy announced in the mini-Budget.
Their view is that taxes should go up as planned by former Chancellor Rishi Sunak. Raising money to pay down borrowing is considered sensible under current economic conditions.
It’s clear Kwarteng is testing the market and hoping for a reversal of the pound.
Meanwhile, the Bank of England is standing in the wings waiting to raise interest rates. Such an action is aimed at calming markets, cooling inflation and restoring confidence in the UK economy.
How Does The World See The Crisis?
Unlike many shocks to the system, such as the coronavirus pandemic and the war in Ukraine, the plummeting pound is a self-inflicted injury.
Prime Minister Liz Truss and her right-hand man Kwarteng have said that their policies may be unpopular, but they could not have envisioned such a catastrophe.
Former US treasury secretary Larry Summers slammed what he called the “utterly irresponsible UK policy.”
The International Monetary Fund (IMF) issued a statement saying: “Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture. It is important that fiscal policy does not work at cross purposes to monetary policy.”
What Action Is The Bank Of England Taking?
The Bank of England is buying back long-term gilts from investors.
Gilts are government IOUs to investors that guarantee a specific rate of interest over the life of the financial instrument.
“Were this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the Bank said in a statement.
“In line with its financial stability objective, the Bank of England stands ready to restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses.”
However, the jury’s out on if the move will work. Despite the bank’s emergency intervention, the pound is still in freefall on currency markets.
What’s The Future For The Pound?
No one can predict the future of the pound and the extended British economy.
A good way to restore confidence in the pound would be to mollify critics by reversing the tax cuts.
But this may be a temporary face-saver now disaster has struck.
Whether they do nothing or act, Liz Truss and Kwarteng have damaged their reputations and that of the Tory ‘safe pair of financial hands’, the stick used to beat Labour in many battles at the polls. These may be injuries from which they never recover.
What’s The Future For Liz Truss And Kwasi Kwarteng?
Discounting the break in Parliamentary business for the state funeral of Queen Elizabeth LL, new Prime MInister Liz Truss and her Chancellor Kwasi Kwarteng have hardly had the time to warm their seats in Downing Street.
What fate holds for both remains to be seen, but the omens don’t look good.
They have tanked the economy in days and seem at a loss over what to do.
THat doesn’t matter so much as reputation and confidence that the markets, investors and other politicians put in the pair. They have destroyed Britain’s economic clout that has taken decades to build and this makes the road to recovery longer and more difficult to negotiate as the trust many had in the economy has evaporated.
Currency Crisis FAQ
How many dollars are there to a pound?
The answer depends a lot on who is managing the foreign exchange and when your pounds are valued. Last week, the pound was reading at $1.22. Five days later, a pound is worth $1.07.
Why is the exchange rate important?
An exchange rate is how much of another currency is worth £1. The result is important to the economic, but especially to businesses, lenders and travellers.
Any goods valued in dollars become more expensive as the pound shrinks in value against the dollar.
OIl and gas are more expensive and stoke inflation and the cost of living crisis even higher. BUsinesses and money lenders can’t set reasonable prices because they do not know how interest rates may fluctuate, while travellers get fewer dollars for the pounds in their pockets.
Has the pound ever seen a worse collapse?
No. The pound has sunk to a record low against the dollar and looks like hitting the bottom is a way off yet.
What have Truss and Kwarteng said about the crisis?
So far, Truss and Kwarteng are letting the Bank of England and markets take the heat and have said nothing about the currency crisis. It’s a dangerous game – saying nothing prolongs uncertainty, while speaking out could spook the markets further.
Has the pound fallen against other currencies?
Over the past ffew days, the pound has lost ground against world currencies such as the Albanian Lek, the Lebanese pound, and the Malaysian Ringgit.
Related Information
Below is a list of related articles you may find of interest.
