Sterling accelerates its recovery after chancellor’s U-turn on taxes

The pound has recovered after Kwasi Kwarteng U-turned on abolishing the top rate of income tax. Saloni Sardana explains what's going on..

Pound coin and US dollar bills
Sterling is clawing its way back up after flirting with parity with the US dollar
(Image credit: © Jason Alden/Bloomberg)

Sterling touched a two-week high against the dollar today after chancellor Kwasi Kwarteng backtracked on plans to scrap the 45p income-tax rate on Monday.

The decision to axe the additional rate of income tax caused a storm in the markets, forcing the Bank of England to ride to the rescue. Sterling fell to a low of $1.0384 on 26 September just days after the mini-Budget and government bond yields surged to levels not seen in over a decade.

However, earlier today sterling briefly touched $1.14 and government bond yields have returned to levels seen before the chancellor’s so-called mini-Budget.

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Why the U-turn is helping sterling

Thanim Islam, market strategist at international business payments specialist Equals Money, said sterling is higher as the chancellor’s U-turn has lowered interest rate hike expectations.

“Chancellor Kwasi Kwarteng has confirmed that the government will not be proceeding with the 45% tax rate. Sterling has risen off the back of the news, and markets have pared back interest rate hike expectations. November's expectation is now for a 1.25% with a further 1% hike in December,” Islam said.

The Bank of England’s emergency intervention to stabilise markets has also helped improve sentiment. Last week the central bank announced it will spend up to £65bn – £5bn every weekday until 14 October.

It is, it said, ready to purchase “conventional gilts with a residual maturity of more than 20 years in the secondary market, initially at a rate of up to £5bn per auction. These parameters will be kept under review in light of prevailing market conditions.”

Are these measures enough to reverse sterling’s slide?

Despite the government’s U-turn, most market watchers believe sterling will remain under pressure due to the headwinds facing the UK economy and the country’s growing debts.

"We do not see today's announcement by the UK chancellor as a game changer for sterling,” said Vasileois Gkionakis, head of Citi’s European FX strategy.

"The borrowing path trajectory will barely change and the big issues at play (unsustainability, higher risk premium) remain in place in our view,” he added.

How will a weaker pound affect you?

Weaker sterling and a higher dollar make the cost of imports more expensive and will raise prices at a time when all Britons are grappling with a cost of living crisis.

Philip Dragoumis, the owner of London-based Thera Wealth Manager, says, “If foreign investors lose confidence in the country, its government and economy, which is happening at scale, sterling could fall much further and the fallout will be devastating. This will keep inflation higher for longer and growth lower.”

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: “The plunging pound is effectively picking our pockets and making us poorer. The market reaction to the tax and spending plans announced on Friday will have a profound impact on everything from the cost of filling up the car and supermarket prices to debt repayments and the value of our savings.

Saloni Sardana

Saloni is a web writer for MoneyWeek focusing on personal finance and global financial markets. Her work has appeared in FTAdviser (part of the Financial Times),  Business Insider and City A.M, among other publications. She holds a masters in international journalism from City, University of London.

Follow her on Twitter at @sardana_saloni