Sterling, UK bonds resume fall as Truss holds firm on tax cuts

The pound snapped a two-day gain and UK government bonds dropped as Prime Minister Liz Truss defended her package of sweeping tax cuts, stoking investor concerns over the country’s fiscal credibility.

The currency traded 1 per cent lower against the dollar at $1.07 (€1.10) and 10-year bond yields surged as much as 21 basis points to 4.22 per cent. Thursday’s slide put the currency on track for its worst month since the UK voted to leave the European Union in June 2016.

The latest declines continue the chaos seen across UK markets in the wake of the government’s mini-budget. The pound hit its lowest-ever level against the dollar this week, borrowing costs soared and the Bank of England was forced to step in to prevent a pension-fund crisis.

Disorderly bond market conditions may have been soothed by the BOE’s intervention on Wednesday, but the action will do little to restore confidence, according to strategists. Truss said that other currencies around the world were also under pressure, and that her economic policy was the “right plan for the UK” in radio interviews.

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“The BOE actions can do little to address the fundamental issue driving GBP markets at present, namely the government’s (lack of credible) fiscal strategy — which is unlikely to be rectified soon, wrote RBC Capital Markets strategists including Peter Schaffrik in a note to clients.

Longer-dated UK government bonds pared some of the record rally sparked after the BOE’s pledge to buy these notes for a limited period to stave off a gilt market crash. Yields on 30-year gilts surged as much as 15 bps to 4.09 per cent, before trading at 3.97 per cent in London.

The UK’s fiscal plan has attracted criticism from the International Monetary Fund and the US, on the grounds that these stimulus measures would fuel inflation. The plans for sweeping unfunded tax cuts are also sparking calls for reversal from members of Truss’ own Conservative Party.

Traders are bracing for further volatile action in the pound, with the cost of hedging swings against the dollar over the next month at levels comparable with the pandemic outbreak and the Brexit vote in 2016.

Some strategists have been calling for the BOE to deliver a more aggressive tightening policy to support the currency, but even that could fail to coax investors back, according to Steven Barrow, head of G-10 strategy at Standard Bank.

“We fear that the market will still see this crisis-like situation as being generated by the government, and one the government will have to fix through an embarrassing policy reversal, he wrote in a note to clients. “If not, we fear the pound will fall much further.” — Bloomberg