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The pound fell to its lowest since late 2023 on Thursday, under pressure from a selloff in global bonds that has driven the UK government's borrowing costs to their highest in over 16 years, which has reignited concern about Britain's finances.
Sterling was last down 0.6% at $1.2295, having touched its lowest since November 2023 earlier in the day, while the cost of hedging against bigger price swings over the coming month jumped to its highest since the March 2023 banking crisis .
Global bond yields have soared this week on the back of concern about rising inflation, reduced chances of a drop in interest rates, uncertainty over how U.S. President-elect Donald Trump will conduct foreign or economic policy and the prospect of trillions of dollars in extra debt.
The UK market has been hit particularly hard. Benchmark 10-year gilt yields have spiked by a quarter point this week alone to their highest since 2008, as confidence in Britain's fiscal outlook deteriorates.
Finance minister Rachel Reeves is facing her first major test, as turmoil in the bond market could force her to cut future spending.
Ordinarily, higher gilt yields would support the pound, but right now, that relationship has broken down, reflecting investors' worry about the country's finances.
"This is the bond market starting to discipline the UK government. And at the moment they want to fight the market, and that never ends well," Lloyd Harris, head of fixed income at Premier Miton Investors, said.
In a statement late on Wednesday, the UK finance ministry said it would maintain "an iron grip" on the public finances.
Sterling has been one of the best-performing currencies against the dollar in the last couple of years, largely because of the Bank of England's policy of keeping UK interest rates higher for longer than other major central banks, which creates an incentive for foreign investors to earn interest from UK assets.
Trump's proposed policies on trade tariffs and immigration carry the risk of fuelling U.S. price pressures, thereby limiting the Federal Reserve's ability to cut rates, which has sent the dollar soaring against virtually every other currency.
The derivatives market shows traders believe the Fed will deliver one rate cut this year, but are not fully pricing in the chance of a second. The UK market, meanwhile, shows almost identical expectations for the BoE.
Britain is struggling with slower growth, persistent inflation and a deteriorating labour market, lagging behind the United States, which shows resilience in virtually every area.
"We had this story of the UK being better than Europe, the currency is doing better, interest rates are higher, everything’s fine (for sterling)," Societe Generale chief FX strategist Kit Juckes said.
“The danger now is people start to get a general sense of why not use sterling for the short side of our long dollar trade," he said.
Britain's economy is flat-lining, while the labour market is deteriorating rapidly, as employers grapple with tax rises in the Reeves' October budget, which contained the biggest overall tax increases since 1993.
The yield on 30-year gilts has hit its highest since 1998, echoing the rise in global long-dated yields.
The last time UK debt was in the eye of the storm was September 2022, when then-Prime Minister Liz Truss unveiled budget plans that contained billions in unfunded tax cuts that sent gilts into freefall, battered the pound and forced the BoE to step in to stabilise the market.
This week's move is nowhere near that of late 2022, when 10-year gilts rose a full percentage point in a week and the pound hit record lows against the dollar.
Indeed, PIMCO, one of the world's largest bond investors, told Reuters late on Wednesday it was still positive about UK debt and said much of the rise in gilt yields was a function of the increase in U.S. Treasury yields, rather than a reflection of deeper problems at home.
(Additional reporting by Naomi Rovnick. Editing by Bernadette Baum and Mark Potter)