What are the causes of the free fall of the pound sterling?

LONDON

- The British pound is in a free fall after hitting its lowest level in history against the dollar, as markets responded to the new British government's economic plan led by Liz Truss.

The new government sparked widespread controversy in Britain after approving a "mini-budget" based on the idea of ​​granting tax exemptions worth about 45 billion pounds ($50 billion) to stimulate the economy.

The British economic markets are experiencing their worst period in years, in light of the continued depreciation of the pound sterling against the rise of the dollar, which prompted the Bank of England to intervene directly to instil a kind of reassurance among investors.

• Why did the value of the pound sterling fall?

Speaking to Al Jazeera Net, Professor John Van Renen, Chair of the Ronald Coss Chair at the London School of Economics (LSE), rejects the idea that the rise in the value of the dollar is the main reason for the decline in the value of the pound sterling.

The British professor stressed that the main reason is that the British government is planning a massive increase in the budget deficit through debt, "without developing a clear plan for the way in which these funds will be paid, which caused a state of panic in the financial markets."

The British economist believes that large tax cuts “will not lead to a high growth rate,” adding that “large government spending and reduced tax revenues will lead to inflation and therefore the value of the pound is worth less for foreign investors who are demanding a much higher return for buying British government bonds.” .

The global market’s response to the British government’s plan to grant huge tax exemptions led to the decline in the value of the pound sterling, which created a state of fear among investors who are getting rid of the pound and do not want to buy it, as it increasingly lost its value to approach with the opening of financial markets last Monday from $1.03, which is the lowest value of the pound in history.

• Why did all this happen?

The idea of ​​a "mini-budget" announced by the Les Terrace government is to give tax breaks and greater tax concessions to the rich in order to encourage them to invest and consume, so it approved a package of exemptions worth 45 billion pounds ($ 50 billion).

This plan is also based on compensating for the shortfall in tax revenues by borrowing about 100 billion pounds ($114 billion), knowing that the government had previously announced that the level of state debt is high and must be sought to reduce it, which put Liz Terrace and her government in an incomprehensible contradiction.

The British government’s plan will motivate people to consume more, which means an increase in demand for goods and services, and in the face of the global shipping and delivery chain crisis, prices will rise again, and with it the already high inflation rate will increase, reaching 10%.

This prompted the Central Bank to intervene urgently to alert the government by issuing a memorandum, warning that it will continue to raise the interest rate, whatever the cost, in order to return the inflation rate to between 2% and 3%.

In the face of the British government's failure to respond to the warnings of the central bank, the latter intervened this time more sharply, and announced its purchase of long-term government bonds worth 5 billion dollars to reassure investors.

It appears that investors have completely lost confidence in the British government's plans, causing the British financial market to lose about 500 billion pounds ($570 billion) in just a week, since the government announced the new budget.

Investors refuse to be convinced that government borrowing will be the solution, and they also fear that higher inflation rates will lead to higher interest rates, which will affect the real estate and loan markets significantly.

The British pound is in a free fall after it reached its lowest level in history against the dollar (Getty Images)

• How will a British citizen be affected?

With the depreciation of the pound sterling, the prices of materials and goods that come from abroad will rise, especially oil imports and all materials that are imported in dollars.

This means that fuel prices will rise again in Britain, and with it inflation rates, which is a nightmare for the Central Bank, which is taking all measures to reduce inflation rates.

Britain imports about 50% of its food needs from abroad, which means that the increase in food prices will inevitably come.

• Is there a way out of this crisis?

There are not many solutions to get out of this crisis other than traditional solutions, the first of which is for the central bank to continue to increase the interest rate in order to motivate people to put the money they have in banks and save it, which will raise the value of the currency and reduce inflation rates.

As for the second solution, the government and the treasury would back down from their new economic plan, and so far, the matter is unlikely, and according to press leaks, Liz Terrass is insisting on her plan and will not back down from it.

The third option is for the government to ask the central bank to intervene in the financial market and buy the pound sterling in exchange for the state's reserves of hard currency, so that the demand for the pound will rise again and return to its normal value.