Despite the tax turnaround, the British economy is not out of the woods

Britain’s debt-ridden economy remains on the brink of recession and the pound is struggling despite a swift fiscal U-turn in the government of new Prime Minister Liz Truss.

Sterling was modestly higher on Monday after recovering from a dollar record low in recent days, following the budget that benefited Britain’s wealthiest during a cost-of-living crisis.

London’s benchmark FTSE 100 fell about half a percent, reflecting losses in global stock markets.

UK gilts, or government bonds, continue to be supported by emergency intervention from the Bank of England after yields surged following the debt-fueled budget late last month.

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“The reversal of the tax cut gives the pound a little more room to recover, but as it only really optimizes the fiscal outlook I don’t expect the recovery to last too long,” IG Index analyst Chris Beauchamp told AFP.

“Gilts continue to reflect this nervousness and until we get a major turnaround and/or more clarity on the fiscal outlook, they should remain under pressure.”

In a dramatic change of plan, Britain’s ailing finance minister, Kwasi Kwarteng, tweeted on Monday that he would no longer scrap the top tax rate of 45 percent levied on the highest earners.

“We understood and we listened,” said the Chancellor of the Exchequer.

No other changes were made to the budget, including removing a cap on bankers’ bonuses, reversing a proposed increase in corporate profits and cutting taxes for all workers.

A move to pay for the cuts with billions of extra pounds (dollars) in additional borrowing had sent sterling to an all-time low near parity with the greenback a week ago, putting pension funds at risk as bond yields rose.

“The reversal of the tax cut … doesn’t do much to bolster the government’s credibility in the eyes of the market, although it does at least show it’s paying attention,” noted Markets.com’s Neil Wilson.

“While the reversal prompted a brief burst of buying, sterling had recovered its losses fairly well over the past week – a harder stance on rate hikes by the Bank of England and its intervention to support the gilt market were key factors.”

Wilson said “sentiment remains quite weak and there could be another pull lower for the pound” as the BoE’s intervention to buy up to £65bn worth of gilts ends next week.

– UK credit warnings –

Analysts have argued that the budget could stoke already sky-high UK inflation, forcing the Bank of England to hike its main interest rate even more aggressively than planned.

Mortgage deals based on the BoE rate have soared over the past week, offsetting the financial benefits to households from the UK government’s energy bill cap.

Ratings agencies have also expressed concerns, with S&P on Friday downgrading its outlook for the UK to negative from ‘stable’ following the impact of markets.

Moody’s had previously warned that Kwarteng’s fiscal strategy was “credit-negative” and could “permanently weaken Britain’s debt sustainability.”

On a positive note, the UK is not yet in recession, revised official data showed on Friday – but that could change in the coming months.

“There is still a lack of confidence in this government and there is a cliff in a couple of weeks when the Bank of England’s emergency purchase program comes to an end,” said Philip Dragoumis of Thera Wealth Management.