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Sterling sinks to new low as 'mini budget' shatters investor faith in UK markets

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LONDON, Sept 26 (Reuters) - The pound collapsed to a record low against the dollar early on Monday, as investors slammed UK markets over the government's fiscal plan, unleashing calls for the Bank of England to take action to restore investor confidence.

Finance minister Kwasi Kwarteng on Sunday dismissed the freefall in the pound that began on Friday after he unveiled his so-called "mini budget", saying his strategy was to focus on longer-term growth and not short-term market reaction. read more

On Friday, he announced he would cut a raft of taxes, but did not detail how the Conservative government, led by newly installed Prime Minister Liz Truss, would fund them. read more

On Monday the pound fell by as much as 5% against the dollar at one point in Asian trading hours, touching $1.0327, its weakest at least since the introduction of decimalisation in the early 1970s. , read more

Lawmakers across the political spectrum expressed alarm at the fallout in the financial markets.

"I started my career as an economist at the Bank of England and like everyone else I'm incredibly worried about what we've seen, both on Friday with market reactions to the chancellor's so-called mini-budget, and also the reactions overnight," Rachel Reeves, financial policy spokeswoman for the opposition Labour Party, told Times Radio.

"It also puts more pressure on the Bank of England to increase interest rates," she added. read more

Scottish First Minister Nicola Sturgeon called for the Westminster parliament to be recalled to hold an emergency session. "It's hard to overstate the scale of the economic crisis caused by Friday's UK budget," she said on Twitter. read more

EYES ON BOE

In light of the rout, strategists and economists said the Bank of England needs to do something to calm markets and restore credibility. read more

"Choice number one is that (Kwarteng) recalibrates his package - politically difficult but economically needed," Mohamed El-Erian, chief economic advisor at Allianz, told BBC Radio 4.

"Choice number two is he leaves it to the Bank of England and in that case the Bank of England would have to hike in an emergency meeting because they don’t meet again until November."

But he said the second option was not a good look.

"That in itself goes against him. Again the image of driving a car with the chancellor foot on the accelerator and the (BOE) governor foot on the brake. That is not a good way to drive the UK economy.”

Markets currently show investors are placing an 88% chance of the BoE raising UK rates by a percentage point to 3.25% at its next meeting, according to Refinitiv data.

Sterling pared some overnight losses to trade down 1.3% on the day against the dollar at $1.07150, while against the euro it was down 0.7% at 89.88 pence, having hit a two-year high of 92.29.

The FTSE 100 (.FTSE) extended losses, falling 0.8% on the day, led by sharp declines in the shares of homebuilders.

'1980S ON STEROIDS'

Two-year gilt yields, which are the most sensitive to the outlook for interest rates and government borrowing, rose by as much as 54 basis points to a high of 4.53%. The yield has risen by around an entire percentage point in the last two trading days alone, reflecting the lack of confidence in the government's ability to fund its raft of tax cuts.

"The British have decided that going back to the 1980s on steroids is the best way to go, and clearly the market is just saying: 'That's not going to work,' on steroids," Michael Every, Rabobank strategist, said.

"The market is now treating the UK as if it's an emerging market. And they're not wrong in terms of the policy response and the naivety of thinking that boosting demand rather than supply is how you deal with a supply-side shock."

Further highlighting the extent to which investors have punished UK assets, the difference in the 10-year borrowing costs of the British and German governments exploded to its widest since 1992, when the UK crashed out of the European Exchange Rate Mechanism.

British government bond prices are on track for their biggest slump of any calendar month since at least 1957, according to a Reuters analysis of Refinitiv and BoE data. read more

Additional reporting by Kylie MacLellan, David Milliken, Andy Bruce and Harry Robertson; Editing by Hugh Lawson
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