UK Backpedals On Income Tax Cut For Top Earners After Rattling Markets

The iShares MSCI United Kingdom ETF EWU and the SPDR S&P 500 ETF Trust SPY both traded higher by more than 2% each on Monday after the U.K. government abandoned its plan to cut taxes for its wealthiest earners.

What Happened? New U.K. Prime Minister Liz Truss shook financial markets and sent the British pound plummeting to new all-time lows against the U.S. dollar when she announced the aggressive tax cuts on Sept. 23.

After repeatedly insisting that she was "absolutely committed" to the cuts, the U.K. government announced Monday that it will not be cutting rates on its highest income tax brackets from 45% to 40%.

Related Link: Bank Of England Begins Purchasing UK Bonds To Stabilize Market, 10-Year US Treasury Rates Hit 4%

Why It's Important: Investors were spooked by the U.K. tax cut announcement and additional investment measures that critics said would disproportionately benefit the wealthy and contribute further to the U.K.'s debt problem as interest rates rise rapidly.

In the days following the initial announcement of the cuts, U.K. government bonds were falling so sharply that the Bank of England announced it was suspending its planned bond selling and will instead begin buying long-dated bonds to stabilize the market.

The yield on 10-Year U.S. Treasury bonds also briefly topped 4% last week ahead of the Bank of England's announcement before dropping back down to 3.63% on Monday.

Related Link: British Pound Drops To All-Time Lows: 'Existential Crisis Is Looming'

Stock and bond prices have been tumbling, and yields have been spiking over concerns about how quickly and how high central banks will need to raise interest rates to bring inflation under control. Year-to-date, the S&P 500 is down 23.5%, while the iShares 20 Plus Year Treasury Bond ETF TLT is down 28.3%.

On Sunday, Bank of America analyst Robert Wood cut his 2023 U.K. GDP growth estimate from -0.4% to -1.2% and said he expects U.K. interest rates to reach a terminal level of 5.25%.

"Recent government actions have added a credibility shock to the four supply shocks previously driving the UK economy shocks - supply chain difficulties, energy prices, labour supply (sickness), and Brexit," Wood said.

The U.S. Federal Reserve has issued three consecutive 0.75% interest rate hikes, but the latest inflation data suggests more hikes could be coming.

The bond market is currently pricing in a 100% chance the Fed will raise rates by at least 0.5% at its next meeting in November and a 57.2% chance the Fed will opt for a fourth consecutive 0.75% rate hike, according to CME Group.

Benzinga's Take: Investors clearly interpreted the walkback on the tax cut as a positive on Monday.

The fiscal policy announcement, the public backlash and then the 180-degree turn has been a major credibility blow for Truss and represents nearly a worst-case scenario for the beginning of her tenure as PM.