The British Pound plunged to all time low of < $1.05 on Monday before recovering to $1.07. The British government’s plans to cut taxes worried investors while the Bank of England warned it would raise interest rates as much as needed to hit its inflation targets.
I don’t understand why the British government decided to cut taxes while the inflation is high. Wouldn’t that spur the demand and push the inflation even higher? They have also been running a trade deficit and a high budget deficit due to the high interest payments on the national debts. Their foreign currency reserve has been low compared to Japan or Switzerland. Tax cuts would further increase their budget deficit and weaken their currency. The British Pound is no longer a reserve currency and they need to be careful of not over stretching their government finance. This tax cut looks like a very risky move.
The strong US dollar is causing problems around the world. The dollar index has been up 23% YTD. Emerging market economies, which often have dollar-denominated debt and import oil and commodities priced in US dollars are facing liquidity and solvency crisis. The Japanese government is buying yen to boost their currency to prevent outflow of capital from Japan. S&P 500 earnings will face an approximate 10% headwind from the surging US dollar as these international conglomerates earn a significant percentage of their revenue overseas.
If you asked me at the beginning of 2022, I would not expect that a US dollar would be worth more than an EURO and almost par with a GBP. Apparently, the European economy is under more strain than the US economy due to COVID, the war and energy crisis. I do worry how long the US dollar can last as the world’s reserve currency. The British Pound used to be the world’s reserve currency. But now it’s under a lot of pressure to devalue even further and at some point it might even need a bailout if their government doesn’t exercise sufficient fiscal discipline.