UK's Truss U-turns on tax cuts; pound and gilts tumble

LONDON (Reuters) -British Prime Minister Liz Truss fired her finance minister Kwasi Kwarteng on Friday, replacing him with former foreign minister Jeremy Hunt, and scrapped part of her big unfunded tax cut plans.

Truss told a news conference Britain would retain a plan to increase corporation tax and said her government needed to act now to reassure markets about its fiscal discipline.

The pound fell against the dollar, trading down 1% at $1.1280, near the day's lows.

Sterling hit a record low and British government bonds, or gilts, went into freefall, after the government released its "mini-budget" on Sept. 23.

Two-year gilt prices, which turned lower before Truss spoke, dropped further in late trade, pushing the yield up 18 basis points to 3.97%, while the blue-chip FTSE 100 index gave up almost all the day's gains to close just 0.1% higher.

Below are comments from analysts, investors and politicians.

DANNI HEWSON, FINANCIAL ANALYST, AJ BELL, LONDON:

“As U-turn’s go it’s a doozy. The freeze in corporation tax wasn’t something most households were talking about around the dinner table, but it was the jewel in the crown of the new PM’s plans to super charge UK economic growth. By allowing companies to keep more of the profits they make, Liz Truss and her former chancellor were banking on that to act as a way to lure more foreign investment and to convince UK based companies to grow right here.

“It may have, temporarily, been an incentive for businesses to overlook the tangle of red tape and additional costs associated with trading in a post Brexit world. But at what cost? Companies had already priced in the new tax rates which had been well signposted and at 25% the UK will still be competitive."

RICHARD MAGUIRE, HEAD OF RATES STRATEGY, RABOBANK, LONDON:

"It continues to leave a very large question mark over how tenable her position is. I suspect that UK assets will continue to remain under pressure going forward potentially until we get another personnel change in the form of Liz Truss herself.

I don't see how that press conference will have done much to shore up the appeal of UK PLC to foreign investors. You see that with the weakness of sterling.

I would expect gilts and the pound to remain under pressure going forward, which does keep the door open to the prospect at least that the Bank of England may ultimately be forced to continue its intervention or at the very least kick the prospect of quantitative tightening into the long grass, maybe that's the more likely outcome."

SAMMY CHAAR, CHIEF ECONOMIST, LOMBARD ODIER, GENEVA

"Today the main story is that there is going to be a U-turn, and there is the acknowledgement by the government that they have to change course. Our understanding of the BOE’s and governor Bailey’s remarks at the IMF is that they probably were not intended for market participants, they were intended for the UK government itself.

It seems that there has been some form of divergence of views between the two entities, our understanding is the Bank of England has won the debate, the UK government is set for a change of course, we don’t know the how and what, but it is pretty clear we’re going to see something much more reasonable out of the UK government."

BEN LAIDLER, GLOBAL MARKET STRATEGIST, ETORO, LONDON:

"We have seen an £18 billion tax U-turn but there is a feeling that the horse may have already bolted. The costs of the mini-budget horror show have already been high and it’s not clear that the corporation tax U-turn will sustainably calm markets.

Whilst expectation of the latest developments has driven a recent recovery in UK bond prices and sterling, both remain weaker than only a few months ago, implying significant extra inflation and financing costs for UK businesses and consumers.

It is questionable this will be enough to underpin markets, after today’s end to the Bank of England’s emergency support of the UK bond market."

PAUL DALES, CHIEF UK ECONOMIST, CAPITAL ECONOMICS:

"It's unlikely that the removal of Kwasi Kwarteng as Chancellor and the new plans to cancel the cancellation (!) of the rise in corporation tax from 19% to 25% from next April will be enough on their own to regain the full confidence of the financial markets. Indeed, after that and the U-turn on the 45p tax cut, there are still unfunded tax cuts of £25bn left over from the mini-budget (down from £45bn originally).

So this isn’t, at the moment at least, a full U-turn on the mini-budget. It’s more a mini-U-turn."

THOMAS MCGARRITY, HEAD OF EQUITIES, RBC WEALTH MANAGEMENT:

"A sizeable U-turn on the unfunded tax plans should be supportive to UK domestic stocks given their sharp underperformance over the past month. It does not, however, change our caution towards UK domestic stocks and maintain a strong preference for more internationally oriented companies given the challenges the UK economy still faces.

There are undoubtedly bargains for longer-term investors within the domestic portion of the UK equity market, but remaining selective is key. The ongoing weakness in the pound will likely result in further opportunistic approaches from both international corporates and PE firms for UK-listed businesses."

BRIAN LEVITT, GLOBAL MARKET STRATEGIST FOR INVESCO, NEW YORK

"The policy was viewed poorly by the markets. It was ill-advised and poorly timed in an inflationary environment. The market believed the policies would exacerbate inflation and the gilt market starting to become unhinged, requiring central bank support. While this doesn’t solve the UK’s inflation and economic challenges, it does help to restore some stability in the UK gilt market and eases pressure on the pound. Further, it reduces the potential for an accident in the UK pension market. Overall, it’s a near-term positive for markets but again doesn’t change the UKs structural challenges."

JAMES SMITH, ECONOMIST, ING

"The key is how big this U-turn is in practice and less about the person in charge. There is a bit of a risk that if we have only a partial U-turn then potentially the markets will come under pressure again next week."

KRISHNA GUHA AND PETER WILLIAMS, ANALYSTS, EVERCORE ISI

"This marks the first time in decades – since at least the 90s – that the financial markets have forced the government of a big developed economy with its own central bank to capitulate on core fiscal ambitions. While the UK situation is idiosyncratic in many respects we see a larger lesson here for governments and investors globally: for a period at least, the bond market vigilantes are back. We think the UK example reduces the risk that Italy’s new populist government will take the kind of UK-style reckless steps that would put it in the firing line."

FORMER UK FINANCE MINISTER PHILIP HAMMOND

"I'm afraid we (the Conservative Party) have thrown away years and years of painstaking work to build and maintain a reputation as a party of fiscal discipline and competence in government."

SUSANNAH STREETER, SENIOR INVESTMENT AND MARKETS ANALYST, HARGREAVES LANSDOWN

"For now the Prime Minister has won breathing space, but the financial markets are highly sensitive and anything less than a co-operative approach with the Bank of England, the Office of Budget Responsibility and international institutions could cause fresh instability."

MUJTABA RAHMAN, MANAGING DIRECTOR, EUROPE, EURASIA GROUP

"Eurasia Group now assigns a 55% probability on Truss being ousted before the next election; Conservative MPs, including some who backed Truss for leader, are already plotting to remove her from office, with Christmas their target date."

ROSS WALKER AND IMOGEN BACHRA, NATWEST MARKETS

"The apparent market and media obsession with tax policies misses the point: the bulk of the fiscal loosening over the next two years stems from the energy support package...Whilst energy support costs could conceivably be lowered via greater targeting (and the government might yet get lucky via falling wholesale prices), there is no political consensus to dismantle this support. Consequently, the scope for a rally in gilts (move lower in yields) and sterling would seem to be limited."

BENJAMIN NABARRO, ECONOMIST, CITI

"The key issue in the near term is the contradiction between monetary and fiscal policy. This is driving up rates expectations, worsening the fiscal fundamentals. It is also weighing on UK institutional credibility."

RACHEL REEVES, OPPOSITION LABOUR PARTY'S FINANCE CHIEF

"This humiliating U-turn is necessary - but the real damage has already been done. This is a Tory crisis, made in Downing Street. It won’t be forgiven or forgotten."

NICK MACPHERSON, FORMER TOP CIVIL SERVANT AT UK TREASURY

"All credit to Bailey of the Bank (Bank of England Governor Andrew Bailey) whose Friday deadline has forced the government to adopt a more orthodox economic policy and thus restore order to the markets."

JAMES ATHEY, INVESTMENT DIRECTOR, ABRDN

"The risk now is that investors have forgotten that there are significantly more problems than just an ill-advised and ill-timed fiscal easing to deal with. Inflation is at multi-decade highs, government borrowing is huge as is the current account deficit. The housing market is likely to suffer a hammer blow from the jump in mortgage rates and the war in Ukraine rumbles on. We may well be through the worst of the volatility but I fear that the UK is nowhere near out of the woods."

CHRIS BEAUCHAMP, CHIEF MARKET ANALYST AT IG GROUP,

"Kwarteng's removal as chancellor, making him one of the shortest holders of that office, hasn’t done much to boost the pound, given that it has already rallied yesterday on hopes of a U-turn on the budget. Now the market will wait to see what is actually decided, and only then will it take a view on giving the government some support in terms of another bounce in GBPUSD and/or a drop in gilt yields. Liz Truss certainly isn’t out of the woods yet."

(Compiled by William Schomberg, Amanda Cooper, Dhara Ranasinghe, David Milliken, Harry Robertson and Lucy Raitano in London and Alden Bentley in New York; editing by Sarah Young and Alex Richardson, Kirsten Donovan)