The UK pound just tumbled to a record low against the dollar. That could drive up food and gas prices for already struggling households.
- The British pound fell to a record low Monday after proposed tax cuts spooked markets.
- Prices are soaring across the UK, with inflation hitting 9.9% last month.
The plummeting British pound looks set to put even more strain on the UK households worst affected by the cost-of-living crisis, by driving food and gas prices even higher.
Sterling fell by almost 5% to hit an all-time low of $1.0350 early Monday after Kwasi Kwarteng, the UK's finance minister, rattled traders by promising more tax cuts are coming.
Investors were already growing worried that the new UK government's plan to reduce tax rates, announced Friday, would damage an economy already hit with inflation at 30-year highs.
The more the pound falls, the more it puts pressure on British people and businesses struggling to buy food or pay their energy bills.
When the pound is weak, that can drive up inflation. That's because goods from other countries become more expensive, if they are priced in stronger currencies such as the dollar.
Businesses have to buy that foreign currency. So when the pound slides against the dollar and other alternatives, they end up spending more to import the same quantities of goods. Those extra costs are then passed on to consumers.
Fuel products like gasoline and diesel are priced in dollars, and are one of the UK's leading imports.
The UK spent nearly 10 billion pounds ($10.7 billion) importing oil, natural gas, and other types of fuel last year, according to the Office of National Statistics. These will become more expensive as the pound weakens.
Soaring fuel import costs will likely be passed onto consumers, analysts have warned. Sterling's plunge has already pushed the average price of petrol above £6 ($6.44), the AA said last week.
At the same time, the UK buys nearly half its food from abroad, according to government figures. The drop in the pound will make things like bananas, coffee, and cereal even more costly — after the Bank of England's governor Andrew Bailey warned in April to brace for "apocalyptic" rises in food prices.
"Households would face the highly unsettling combination of more uncertain income streams, higher borrowing costs and a further erosion in their purchasing power due to greater imported inflation," top economist Mohamed El-Erian said in a Guardian comment Friday.
"Businesses already struggling to keep afloat in the midst of an energy and cost-of-living crisis would risk being tipped into bankruptcy," the chief economic advisor to insurance giant Allianz added.
El-Erian is among many analysts and economists urging the Bank of England to aggressively raise interest rates to support the UK currency — with some calling for a 100 basis point rise.
The central bank's policymakers aren't scheduled to meet until November 3, but the BOE can hold an emergency gathering in exceptional circumstances.
Interest rate hikes could chip away at inflation, as they are starting to do in the US — but they also make mortgages and household credit bills more expensive. That's because interest rates for borrowing — such as bank loans and credit cards — typically follow the pace set by the Bank of England.
A combination of rising rates and lower taxes could drive up economic uncertainty, given the central bank will be trying to take money out of the system while the government tries to boost it.
"The resulting macro policy configuration would be equivalent to a car being driven with one foot on the brake and the other, 'pedal to the metal', on the accelerator – a method that increases the risk of both economic and market accidents," El-Erian said.
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