(Bloomberg) -- The pound pared its losses against the dollar after earlier hitting a record low, amid speculation the Bank of England will respond to the sharp moves in markets in the wake of the UK government's plans to cut taxes and ramp up borrowing.
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Sterling was trading around $1.08 as of 4 p.m. London, down 0.6% on the day, after earlier plunging almost 5% to $1.0350.
Pressure on shorter-maturity government bonds also eased, with five-year gilt yields trading 41 basis points higher on the day at 4.48%, having climbed to 4.61% earlier, the highest since 2008.
The wild market swings are a response to new fiscal measures, including sweeping tax cuts that investors fear will fuel inflation and increase borrowing at a time of rapidly rising interest rates. The rout has been compounded by a bout of dollar strength that has wreaked havoc across currency markets worldwide.
"We're not a million miles from the bottom, but we will get a lot of volatility both ways in the coming days and possibly weeks," said Kit Juckes, chief currency strategist at Societe Generale. "This isn't going to really improve, apart from anything else until the dollar turns around, but also until people start to be more confident about the management of the UK economy."
So far, there's been silence from the government and the Bank of England. The BOE has yet to decide whether to comment on conditions, and is watching the market closely, according to a person with knowledge of the situation. Sky News earlier reported that the central bank is expected to make a statement Monday.
In the meantime, traders have ramped up bets on BOE rate increases, pricing in around 185 basis points of tightening by the next policy meeting in November. They see the key rate peaking at close to 6% by November 2023. Some are even bracing for emergency action, wagering on about 50 basis points of rate hikes over the coming week, according to swaps pricing.
Given that Prime Minister Liz Truss appears to be throwing out traditional economic orthodoxy, it may be the BOE is concerned about its own place in this new world.
"They are more at risk than ever of being painted as political, their independence previously questioned by Truss, though not since she was elected," said Elsa Lignos, global head of FX strategy at RBC Capital Markets. "If they avert a collapse in the pound with higher rates they will get no credit for the hypothetical crisis they averted but reap plenty of opprobrium for raising borrowers' costs."
The BOE previously tried to prop up the pound on Black Wednesday, using rate hikes and currency purchases when sterling crashed out of the Exchange Rate Mechanism, a system linking a number of European currencies. That defense, which took place 30 years ago this month, ultimately failed.
"We think that the BOE is too psychologically scarred from the events of 1992 to try defensive currency-related rate hikes," said Chris Turner, FX strategist at ING. "What happens if the BOE hikes 300-500 basis points and GBP/USD ends up trading lower?"
(Updates pricing throughout, adds analyst comment in fifth paragraph. A previous version of this story corrected the pound price in the second paragraph.)
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