British market sell-off gets reprieve on talk of Truss U-turn

Sterling buoyed by reports that officials are working on reversal of sweeping tax cuts

The British government of Liz Truss has faced growing criticism and waning support in opinion polls over the tax measures.

Sterling surged the most in more than two years, buoyed by reports that British government officials are working on a U-turn of the sweeping tax cuts proposed by the country's prime minister Liz Truss.

Sterling climbed above $1.13 at one stage and the yields on British sovereign 30-year debt dropped on bets that fiscal changes would improve the country’s debt sustainability.

The sharp moves are the latest turbulence to hit UK markets since chancellor Kwasi Kwarteng unveiled a package of tax cuts last month that would likely strain Britain's public finances. 

Growing criticism from other MPs and waning support in the opinion polls has also been piling pressure on the new UK administration to make adjustments to policy. 

UK officials at No 10 Downing St and the UK treasury are discussing how they can back down from the package of tax cuts, according to a person familiar with their conversations. The officials are drafting options for Ms Truss, but no final decision has been taken and they are waiting for Mr Kwarteng to return to London from Washington, the source said. 

Regardless of what happens to Ms Truss’s policies, investors should still be wary of betting on the pound, according to Adam Cole, a strategist at RBC Capital Markets. He said that he would be looking to sell the currency above $1.13. 

Meanwhile, the fallout from the British crisis has been felt around the world. 

Market reprieve

Yesterday's market reprieve came after days of stress in global bond markets.

UK pension funds had been dumping assets to meet margin calls as the Bank of England with the reverberations being felt everywhere from Sydney to Frankfurt and New York.

In the US, investment-grade corporate bonds are falling. UK pension funds have contributed to the selling pressure in recent days, according to one Wall Street trading desk.

In Europe, leveraged loans bundled into bonds known as collateralised loan obligations have been under pressure, with selling having renewed this week. In Australia, investors have been asked to bid on mortgage-backed securities that were being auctioned off. 

UK pensions are selling to meet margin calls on derivatives they used to help ensure they could keep paying retirees even if interest rates changed, using a technique called liability-driven investing. The offloading that first began after a spike in UK bond yields two weeks ago was renewed this week, when the Bank of England confirmed that it plans to end an emergency bond buying programme tomorrow. 

If the Bank of England holds course and ends the buying programme, the next crunch date could be October 31. That’s when Kwarteng will announce his medium-term fiscal strategy and the non-partisan office for budget responsibility will publish an accompanying assessment. 

“What’s happening in the UK could lead to further volatility also in the eurozone market,” said lberto Gallo, co-founder of hedge fund Andromeda Capital. 

• Bloomberg