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Pound and gilts rally as Kwarteng U-turns on top tax rate

UK Chancellor Kwasi Kartweng   (PA)
UK Chancellor Kwasi Kartweng (PA)

The crisis in the financial markets eased today as sterling and gilts gave the thumbs up to Kwasi Kwarteng’s embarrassing U-turn on the 45p top tax rate.

By mid-afternoon the pound was up two third of a cent against the dollar at $1.1236, although it had been almost a cent up earlier in the day ahead of the Chancellor’s climb down.

Gilts traders were also more relaxed about the outlook for borrowing after the £2 billion giveaway for highest earners - one of the key triggers for last week’s extraordinary market turmoil - was unceremoniously axed for being a “distraction.”

The yield on the benchmark 10-year gilt fell by 19 basis points at one stage to drop below 4% for the first time since September 23. By mid-afternoon the yield was 3.894%.

Last week, a 10-year gilt yield had jumped to 4.5%, up from 3.5% before the Chancellor’s catastrophic mini-budget. Yields on other bonds across the curve also fell significantly.

The money markets also reined in their expectations for interest rate rises, now only pricing in a 1.25% hike at the next meeting of the Bank of England’s Monetary Policy Committee (MPC) early next month compared with 2% last week.

Last week the bond market was suggesting that the bank rate would be at least 6% next year. That price now looks more like 5.5%, still a huge rise on the present 2.25%.

Many thousands of people have fixed rate mortgage deals coming to an end this year and next.

Guy Foster, chief strategist at RBC Brewin Dolphin, said: “The derivatives market is now signalling one less rate increase since this U-turn on additional rate tax. The move is symbolic more than fundamental with the tax cut making up around £2 billion of about £40 billion per year increase in funding requirement announced at the mini-budget.”

Tony Danker, director-general of the CBI welcomed the U-turn. He told Radio 4: “Businesses up and down the country want the markets to stabilise. That is an absolute precondition to investment and growth, and it’s a precondition to getting onto these very good reforms.”

William Marsters, senior sales trader at Saxo UK, said: “The move to reverse the tax cut decision won’t add much to the government’s balance sheet and so will be seen more as a signal to investors than anything else.

“As far as government credibility goes, investor concern might be more focused around the government’s disconnect internally with Prime Minister Truss saying the top-tier tax cut decision was made by Chancellor Kwarteng, and other cabinet members were not consulted on the matter.”

Late last week Standard & Poor’s cut the outlook for UK gilts to “negative” from “stable” on fears the package of tax cuts will just increase debts and deficits.

Those fears remain, even if markets were calmer today.

Joshua Raymond, director at financial brokerage XTB, said: “Until investors get clarity in the scale of borrowing needed and costs, which means a detailed OBR forecast, the pound Sterling volatility will likely continue.”