LONDON – The first fiscal policy announcement from new British Prime Minister Liz Truss's government has been met with one of the most pronounced market sell-offs in recent history.

The British pound hit an all-time low against the dollar in the early hours of Monday morning, dropping below $1.04, while the U.K. 10-year gilt yield rose to its highest level since 2008, as disarray continued following Finance Minister Kwasi Kwarteng's "mini-budget" on Friday.

Jim O'Neill, former Goldman Sachs Asset Management chairman and a former U.K. Treasury minister, said the pound's fall shouldn't be misinterpreted as dollar strength.

"It is a consequence of an extremely risky budget by the new chancellor and a rather timid Bank of England that, so far, has only raised rates reluctantly despite all the clear pressures," he told CNBC Monday.

The announcement Friday featured a volume of tax cuts not seen in Britain since 1972 and an unabashed return to the "trickle-down economics" promoted by the likes of Ronald Reagan and Margaret Thatcher. The radical policy moves set the U.K. at odds with most major global economies against a backdrop of sky-high inflation and a cost-of-living crisis.

The fiscal package – which includes around £45 billion in tax cuts and £60 billion in energy support to households and businesses over the next six months – will be funded by borrowing, at a time when the Bank of England plans to sell £80 billion in gilts over the coming year in order to scale back its balance sheet.

The rise in 10-year gilt yields above 4% could suggest the market expects that the Bank will need to raise interest rates more aggressively in order to contain inflation. The yield on 10-year gilts has risen 131 basis points so far in September — on course for its biggest monthly rise recorded within Refinitiv and Bank of England data going back to 1957, according to Reuters.

Truss and Kwarteng maintain that their sole focus is to boost growth through tax and regulatory reform, with the new finance minister suggesting in a BBC interview on Sunday that more tax cuts could be on the way. However, the plan has drawn criticism for disproportionately benefiting those with the highest incomes.

The independent Institute for Fiscal Studies also accused Kwarteng of gambling the U.K.'s fiscal sustainability in order to push through huge tax cuts "without even a semblance of an effort to make the public finance numbers add up."

As the markets continue to balk at the new prime minister's plans, Sky News reported on Monday morning that some Conservative Members of Parliament are already submitting letters of no confidence in Truss – only three weeks into her tenure – citing fears that she will "crash the economy."

'Currency crisis'

Vasileios Gkionakis, head of European FX strategy at Citi, told CNBC on Monday that the massive fiscal stimulus and tax cuts, financed by borrowing at a time when the Bank of England is embarking on quantitative tightening, amounted to the market demonstrating an "erosion of confidence" in the U.K. as a sovereign issuer, leading to a "textbook currency crisis."

He argued that there is "no empirical evidence" behind the government's claim that expanding fiscal policy in this fashion will drive economic growth, and suggested that the likelihood of an emergency inter-meeting rate hike from the Bank of England was increasing.

"That being said, for it to provide at least a meaningful temporary relief, it would have to be big, so my best guess is that it would have to be at least 100 basis points of a hike," Gkionakis said, adding that this may bring about a sterling recovery.

"But make no mistake, another 100 basis points is going to send the economy into a tailspin, and eventually is going to be negative for the exchange rate, so we are in this situation right now where sterling has to depreciate further in order to compensate investors for the higher U.K. risk premium."

The prospect of further acceleration to the Bank of England's monetary policy tightening was a common theme for analysts on Monday.

"This fiscal development implies that BoE will now need to tighten policy more aggressively than it otherwise would have in order to counteract the additional price pressures stemming from the fiscal stimulus measures," Roukaya Ibrahim, vice president at BCA Research, said in a research note Monday.

"While rising bond yields typically support the currency, the pound';s selloff highlights that market participants are skeptical that foreign investors will be willing to fund the deficit amid a poor domestic economic backdrop."

Ibrahim added that this would imply further suffering for U.K. financial markets due to the "unfavorable policy mix" over the near term.

Further clarifications expected

The shock to markets came largely from the scale of tax cuts and absence of offsetting revenue or spending measures, which raised concerns about the country's fiscal strategy and policy mix, according to Barclays Chief U.K. Economist Fabrice Montagne.

The British lender expects the government to clarify its plans to balance the books through "spending cuts and reform outcomes" ahead of the November budget statement, which Montagne suggested "should help to deflect immediate concerns relating to large unfunded tax cuts."

Barclays also expects the government to launch an energy saving campaign over the next month, aimed at facilitating demand destruction.

"Taken together, we believe fiscal rebalancing and energy saving should contribute to contain domestic and external imbalances," Montagne said.

In the context of supply impairments, a tight labor market and almost double-digit inflation, however, Montagne suggested that even the smallest positive demand shock may trigger huge inflationary consequences.

This could cause the Bank of England to deliver a 75 basis point hike to interest rates in November once it has fully assessed the effect of the fiscal measures, he said.

A possible mitigating factor, Montagne noted, was that while the U.K.'s trade performance may be bleak and its deficit wide, the fact that the country borrows domestically and invests abroad means its external position improves when the currency depreciates.

"While public debt levels are large, fiscal sustainability metrics are not critically different from peers, in some cases even better. In our view, that should mitigate immediate concerns regarding risks of a Balance of Payment crisis," he said.

Barclays does not see the U.K.'s economic fundamentals calling for a sharper hike than the bank's new baseline expectations of 75 and 50 basis points at the next two meetings, and does not expect the MPC to deliver an emergency inter-meeting hike, but rather to wait until November to reset its narrative in light of new macroeconomic projections.

"Similarly, we do not expect the government to reverse course at this stage. Rather, as mentioned above, we expect it to pull forward by speeding up structural reforms and the spending review, in an attempt to deflect immediate market concerns," Montagne added.