Goldman Sachs sees deeper UK recession after tax U-turn

(Reuters) -Goldman Sachs has downgraded Britain's economic outlook and warned of a deeper recession next year after Prime Minister Liz Truss last week removed Kwasi Kwarteng as chancellor and scrapped parts of their unpopular economic package.

The Wall Street bank revised its 2023 UK economic output forecast to a 1% contraction from an earlier forecast for a 0.4% output drop, with core inflation seen at 3.1% at the end of 2023, down from 3.3% previously.

"Folding in weaker growth momentum, significantly tighter financial conditions, and the higher corporation tax from next April, we downgrade our UK growth outlook further and now expect a more significant recession," Goldman analysts led by Sven Jari Stehn said in a note dated Sunday.

With financial markets in turmoil, Truss said on Friday Britain will go ahead with corporation tax rise to 25% next year, making an U-turn on a pledge to freeze it at 19% after the UK economy also unexpectedly shrank in August.

Goldman Sachs hinted at possible further policy reversals in the coming days, but said it was less likely that the energy price guarantee program will be revised since it was needed to protect household bills during the winter.

It also sees less pressure on the Bank of England (BoE) to tighten aggressively and lowered its estimate of terminal Bank Rate to 4.75% from 5%, forecasting 75-basis-point hikes in November and December from the central bank.

"The persistence of core inflation and the continued tightness in the labour market suggests that the BoE still needs to take monetary policy into significantly contractionary territory," the Goldman analysts wrote.

"That said, following PM Truss's policy reversal we think there is less pressure for the BoE to act aggressively in the coming meetings," they added.

(Reporting by Jahnavi Nidumolu and Subhadeep Chakravarty in Bengaluru; Editing by Tomasz Janowski and Shailesh Kuber)