Pound has already lost nearly 400 pips on Friday, then this morning sank further by 5%. The reason was the new Chancellor of the Exchequer Kwasi Kwarteng's vow to continue cutting taxes, which raised fears of another sharp increase in inflation and public debt. The decline was the biggest intraday drop since March 2020, when investors panicked over the emerging Covid-19 pandemic. A number of economists have urged the Bank of England to take actions, but this will only exacerbate the fears in global financial markets and put the administration of Liz Truss at risk as the UK continues to grapple with the cost-of-living crisis.
Nevertheless, the collapse of the pound indicates that markets do not trust the new UK government, especially since the national currency is rapidly moving towards parity and there is a huge chance that the situation will only worsen further.
Kwarteng laid out the UK's most drastic tax relief package since 1972 yesterday, cutting fees on both workers' and companies' wages in an effort to boost the long-term potential of the economy. He also lowered stamp duty on property purchases, lifted a cap on bank bonuses and reaffirmed support for households and businesses on rising electricity bills over the next six months.
Although pound bounced up earlier, traders are set to further decline as the options market is currently showing a 60% chance of it weakening to parity against dollar this year. A massive sell-off is sure to force the Bank of England to act more aggressively, and if the situation continues to go downhill, there will be an extraordinary increase in interest rates between meetings.
Pound has so far collapsed to an unprecedented level - 1.0360, which creates quite a few problems. A correction will occur only when buyers become more active this week. It will surely open a direct path to the highs of 1.0700, 1.0760 and even 1.0805. But if pressure continues, GBP/USD will fall to 1.0500 and 1.0430.
In terms of EUR/USD, a lot depends on 0.9605 because a drop below it will push quotes lower to 0.9560, 0.9510 and 0.9455. Price will increase only when buyers manage to bring the pair to 0.9710, then push it to 0.9770, 0.9810 and 0.9860.
