British pound hits a record low in big warning for Australia

The British pound has crashed to an all-time low against the US dollar as the currency’s slump serves as a major warning for Australia.

The UK pound has plunged to its lowest level on record in a catastrophic day for the British currency that serves as a major warning for Australia.

As the next chart shows, the pound has taken an enormous beating over the last few months, and on Monday, Australian time, it capitulated completely.

It crashed to even lower levels than the dark days of the 1980s and now buys just over one US dollar, whereas it bought $1.50 as recently as 2015.

The UK pound plunged to its lowest level on record vs US dollar.

One mercy is the Queen wasn’t around to see the currency with her face on it debased to such an extent.

Two big reasons and one big warning

Why now?

Reason one for the unprecedented collapse in the pound is the world is becoming more dangerous, financially speaking. Recession talk is in the air, as central banks try to slow down their economies to stop inflation from getting any higher. When recessions happen, investors like to move their money into safe investments. And the safest investment is US bonds. They call it a safe haven.

To buy US bonds you need to have US dollars, so investors need to buy US dollars on the currency markets. The extra demand makes the US dollar go up, just like extra demand for any product makes the price go up. (The effect is exacerbated by currency traders trying to get ahead of the game, buying USD in the expectation that bond traders will soon need to do the same.)

UK Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng. Picture: Dylan Martinez/WPA Pool/Getty

So part of the reason the pound is getting pounded is that the US dollar grows strong as the world economy gets wobbly. (The Australian dollar is also down against the USD.)

Reason two is the UK is looking less and less like a safe haven. The new government is cutting taxes and spending up big rather than paying back debt, and investors don’t like it.

The UK got a new Prime Minister on September 6 (two days before the Queen died) and her new Treasurer put out a mini-budget shortly afterwards. The budget has been extremely unpopular, giving big tax cuts to the rich in the hope that will stimulate the British economy to perform better.

Tax cuts are not likely to achieve that, while they are likely to accelerate inflation, so the British central bank is expected to react by lifting official interest rates. It’s like having one foot on the accelerator and one on the brake at the same time: you don’t go anywhere and wreck the engine.

The British currency crashed to near parity with the US dollar. Picture: Tolga Akmen/AFP

The warning

Australia’s new Treasurer, Jim Chalmers, is bringing down his first budget in October, and he should be looking at the UK situation with serious concern. Because he proposes – like the UK – to deliver big tax cuts that mostly benefit high income earners. These tax cuts have become known as the “stage three tax cuts.” They are an old idea, brought in by the Turnbull government in its 2018-19 budget under then-Treasurer Scott Morrison.

The tax cuts were supposed to be rolled out over the following seven years, but we don’t have to stick to that plan – the world has changed quite a bit since 2018. For one thing, inflation is now the enemy. When the government cuts taxes it encourages spending, and spending makes businesses put up prices, creating inflation. We don’t need more of that right now!

Another relevant change is we have enormous debt. Much of it is caused by the handouts during the pandemic. The Commonwealth government is forecast to soon go over a trillion dollars. If the government leaves the taxes in place it can help return the budget to balance sooner and prevent the debt growing larger.

If Mr Chalmers emulates the UK and unleashes a budget that delivers big tax cuts, he must acknowledge that he does so having seen the warning signs. Financial markets could deliver an instant verdict that they consider such a move irresponsible.

The upside?

With the pound in the doldrums, your trip to the UK just got a lot more affordable.

The pound is not doing quite so badly against the Aussie dollar as against the all-conquering US dollar, but it is still weak, meaning we can buy over 60 pence now with an Aussie dollar.

The UK economy might be a smouldering wreck when you get there but you can march into Harrods knowing our dollar will go further than any time in years.

Jason Murphy is an economist | @jasemurphy. He is the author of the book Incentivology.

Originally published as British pound hits a record low in big warning for Australia