The pound edged higher as the UK government announced a U-turn on the 45p top tax rate, one of the most controversial points of a £45bn fiscal package.
Sterling jumped by as much as a cent to over $1.126 – its highest level in over a week, just a week after it slumped to a record low around $1.035.
The U-turn comes after strong opposition from several Tory MPs, after the mini-budget caused chaos in the financial markets last week amid concerns that the UK was increasing borrowing to fund tax cuts for the rich.
We get it, and we have listened. pic.twitter.com/lOfwHTUo76
— Kwasi Kwarteng (@KwasiKwarteng) October 3, 2022
But sterling fell back to around $1.12 after chancellor Kwasi Kwarteng said he would not resign. He declined to admit the planned tax cut was a mistake, telling the BBC: “What I admit was that it was a massive distraction on what was a strong package.”
Kwarteng said the decision had been made “in a spirit of contrition and humility” and insisted the government was “100% focused on the growth plan”.
Viraj Patel, macro strategist at Vanda Research, predicts the pound may push higher this week, as the damage caused by Kwasi Kwarteng’s mini-budget is undone.
My estimates suggest $GBPUSD should be trading around 1.13-1.14 if the entire 'Kami-Kwasi budget' risk premium is unwound. Seems reasonable we get there in the next few sessions... 45p tax cut was the nail in the coffin for the pound last week. Taking this out is a big deal pic.twitter.com/LXwfCp3PWD
— Viraj Patel (@VPatelFX) October 3, 2022
Jan von Gerich, chief analyst at banking group Nordea, said that from a market perspective, scrapping plans to axe the 45p top rate of tax is "a good step in the right direction”.
"It will take time for markets to buy the message but it should ease the pressure," he warned, adding that "questions still remain and sterling will likely remain under pressure.”
Director-general of The Confederation of British Industry (CBI) Tony Danker has welcomed the chancellor’s decision to U-turn on cutting the 45p tax rate, saying it become a “distraction” from his other economic reforms which he thinks will “make a real difference to growth”.
He told BBC Radio 4’s Today programme: “Here was a package with some really strong economic reforms that businesses have been waiting for for years in fact and clearly, politically the 45p had become a distraction, and probably more importantly businesses up and down the country want the markets to stabilise, that is an absolute pre-condition to investment and growth.
“And it’s a pre-condition to getting on to these very good reforms, so yes I think it’s a good development this morning.
“What’s really been happening economically with this budget is that a set of very strong economic reforms, which are, by the way, controversial enough in this conference, it was absolutely essential to get them passed, but the markets were anxious about the package overall and I think as we see the markets stabilise, which I very much hope they do, that means, we hope, the investment climate stabilises, and we can get on to these economic reforms because I think they’ll make a real difference to growth.”
Jane Foley, head of FX Strategy at Rabobank, said the UK government still has work to do in order to recover its credibility
“Clearly sterling has performed better on the news, but there are still a lot of questions, ultimately the 45 pence tax rate was only a small part of the unfunded tax cuts announced.
"The question remains is this enough? The answer will be clear in a few weeks’ time when the bank of emergency measures end. “UK assets, the pound and gilts are not out of woods yet, and the British government has a lot to do to get back credibility.”
The pound’s volatility “serves as a salutary reminder of the need to deliver credible policy, particularly in the current climate of high inflation and asset price weakness,” Australia & New Zealand Banking Group Ltd. strategists Brian Martin and Mahjabeen Zaman wrote in a note. “UK policy setters need to get ahead of market anxiety.”
UK government debt prices rose after chancellor Kwasi Kwarteng announced his tax U-turn, pushing yields lower.
The 10-year gilt yield fell 0.07 percentage points to 4.02%, after hitting a high of almost 4.6% during last week’s market turmoil.
Watch: Truss admits mistakes but sticks by her plan – and blames chancellor for top-rate tax cut idea