UK Government folds Under Pressure and U-Turns on Tax Plans

October 07 20:55 2022

Sterling has recovered most of its recent losses against the dollar, following a U-turn from the British government over tax cut proposals that had spooked investors and sent the pound into freefall.

James Tanner at Bickley Consulting warns though that the worst is yet to come for the UK economy, with traders still more negative than ever about the pound’s prospects.

UK finance minister Kwasi Kwarteng had announced a number of measures in a “mini-budget”, the most controversial of which was a removal of the UK’s highest band of income tax. Following a market reaction that sent the pound tumbling and fierce opposition from within his own party, Kwarteng reversed that decision days later.

Investor confidence remains shaky though, says Tanner, who believes further policies announced by Kwarteng will also need to be reversed to steady the ship.

“The U-turn on the 45% tax plan has done a little to calm investors, but no more than a little,” said Tanner. “The credibility of the new government in the UK has been shot down almost immediately, and it will be a tough process to regain trust.

“Mr. Tanner added that parity with the dollar still shouldn’t be ruled out despite sterling’s recent recovery, pointing out that UK government bonds had already given up most of the gains made following the about-face from Kwarteng.

Wall Street banks also predicted the pound would hit parity with the dollar this year, and whilst such calls have become more cautious following sterling’s revival the outcome is still solidly on the table. Options traders are the most negative on the currency they have been since the 2016 Brexit vote.

The widely-accepted view is that further policy reversals will be needed to assuage investors, something Prime Minister Liz Truss has ruled out. Truss and Kwarteng had previously ruled out the tax rate U-turn though, before the change of heart heavily influenced by dissenting voices within their own party.

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