The British Pound Is Getting Crushed. A Crisis Is Brewing.

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The dollar may be battering all currencies at the moment, but the U.K. pound is sinking particularly fast as the government’s attempts to kick-start growth backfire.

Take Japan as a contrasting example. On Thursday, the third-largest economy took the extraordinary step of buying yen to shore up its currency. While that is at best a short-term fix, it did get markets to react in the right direction.

In the U.K., however, a new government under Prime Minister Liz Truss is gunning for a longer-term solution. On Friday, the government unveiled a new package of measures that it hopes will ignite growth after years of struggle under Brexit, the Covid pandemic, and the current energy crisis.

The theory is that boosting growth will make the U.K. economy more competitive, increase the attractiveness of investing in Britain, and bolster tax receipts as the national income increases. For Truss and her finance chief Kwasi Kwarteng, the means to achieve that goal is the biggest round of tax cuts in decades, costing £161 billion ($180 billion) over the next five years.

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But the theory is running into problems in practice. Bond investors, who were told that the new plans would lead to £62 billion in additional issuance over the next six months, went into revolt. Yields surged—five-year gilts jumped by the most in a day since 1991, and the benchmark 10-year bond yield climbed by the most since 1998.

The pound, already at its weakest since the 1980s, fell further to around $1.10.

The ructions in the U.K. matter for U.S. investors. Pension funds and other financial institutions buy foreign bonds as so-called risk-free assets, because they will always be paid back as long as the government issuing them also prints its own currency.

The U.K. is particularly reliant on investors from outside the country for funding. Its current-account deficit, or the difference between how much foreigners spend on goods and services in the U.K. and what the U.K. spends overseas, has climbed to more than 8% of the economy from around 2% at the end of last year.

If foreign buyers are deciding to stop putting money into the U.K., the pound’s drop stands to get even steeper.

“It is American and European pensioners that will need to purchase the extra issuance of gilts,” Deutsche Bank analyst George Saravelos wrote in a note. “But in an environment of such high global uncertainty, we worry that the price foreigners will ask in return for financing the new stimulus will be very high.”

In short, investors are passing judgment on Truss’s plan to boost growth. They don’t think it will work, and they don’t want to pay for it. With the Bank of England also raising short-term interest rates as fast as it can, that’s a recipe for a crisis in the coming months.

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