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Pound Collapse Puts Dollar Parity, Emergency Bank of England Rate Hikes in Focus

Britain's new government said it will continue focusing on tax cuts and new borrowing to boost growth even as markets push the pound to a record low against the U.S. dollar.

The British pound slumped to an all-time low against the U.S. dollar in overnight trading Monday, prompting increased speculation of an emergency rate hike from the Bank of England over the coming days.

Sterling was marked as much as 5% lower against the greenback, at an historic low of 1.0325 during its overnight trough extending declines from last week's currency market rout that followed a 'mini budget' statement from finance minister Kwasi Kwarteng.

That statement, unveiled in only the third week of Prime Minister Liz Truss' new government, included $80 billion in new borrowing -- the largest increase since 1972 -- to fund both a planned cap on consumer energy prices over the coming winter and tax cuts for the highest earners in the world's fifth largest economy.

"I want to see, over the next year, people retain more of their income, because I believe it's the British people that are going to drive this economy," Kwarteng told the BBC on Sunday. 

Money market trading in the U.K. is now pricing in at least another 1.75% in near-term rate hikes from the Bank of England in order to defend the currency -- which is now trading at 1.0725 -- from sliding to parity against the greenback. 

The U.S. dollar index, which tracks the greenback against a basket of six global currencies, was marked 0.37% higher at a fresh two-decade high of 113.627. 

"We now see rates rising to more than 4% next year, compared with a peak of 3% previously," Moody's Investors Service said Monday. "[Kwarteng] also stressed the government’s aim of raising the trend rate of economic growth to 2.5%, though this will be difficult to achieve."

The Bank of England, which raised its key Bank Rate last week by 50 basis points, to 2.25%, as part of its ongoing effort to tame the fastest inflation in decades, could also intervene directly into foreign exchange markets to prop up the pound, either with its $80 billion in reserves or under the behest of the U.K. Treasury. 

"Since a U-turn on freshly-announced fiscal measures seems unlikely just yet, many are calling for more significant tightening by the Bank of England," said ING's global markets head Chris Turner. "However, an FX-related hike may prove unsuccessful (and) cable may soon hit parity." 

The pound's collapse has also triggered a surge in government borrowing costs, with yields on benchmark 2-year U.K. Gilts, the equivalent of a Treasury bond, rising more than 95 basis points over the past two trading sessions to a 2008 high of 4.559%.

Benchmark 10-year Gilt yields, meanwhile, are on track for their biggest monthly increase since 1957, according to Reuters data, and were last seen trading at 4.1%, while 5-year paper surged 50 basis points during today's session alone to change hands at 4.571%.