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U.K. Markets Rally as Investors Bet Government Will Roll Back Tax Plans

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LONDON—U.K. financial markets rallied Thursday as investors bet the government would reverse course on its recent tax-cutting plans, while the country’s Prime Minister

Liz Truss

grapples with a growing rebellion from both investors and lawmakers from her own Conservative Party.

On Thursday, Conservative lawmakers and some government officials speculated that Ms. Truss might change tack on one of the key planks of the tax cutting plan: to reverse a planned rise in the headline rate of corporation tax to 25% from a current 19%, which the previous government of

Boris Johnson

had promised to keep public finances stable.

U.K. Chancellor of the Exchequer

Kwasi Kwarteng

said during an International Monetary Fund meeting in Washington on Thursday “our position hasn’t changed,” adding that he would present a more detailed fiscal plan on Oct. 31. He didn’t, however, specifically rule out a cut to the corporation tax rate. He also batted down reports in the British media that his job was on the line. “I am not going anywhere,” he said.

Any about-face would be the second major U-turn since the government’s so-called “mini budget” was announced last month. Last week, the government scrapped its plans to cut the top rate of income tax to 40% from 45%.

The yield on the 30-year gilt fell 0.31 percentage point to 4.55%, data from

Tradeweb

showed. The pound gained 2.1% against the dollar, to $1.1341.

“We had the political analysts come out and say the government is planning the mother of all U-turns and then the outlook starts to improve,” said

Simon Harvey,

the head of foreign-exchange analysis at Monex Europe. He said the extent of the change would be important. “All this is very dependent on the size of the U-turn and what fiscal policy is going forward,” he added.

In power for just over a month, Ms. Truss has been hit by crises ever since her government announced plans to pair big new subsidies for energy prices this coming year with the biggest tax cuts in a generation. Concerns about the plan’s impact on inflation and government debt sparked turmoil in U.K. financial markets, prompting the central bank to launch an emergency program of buying government bonds. The Bank of England was seeking to prevent the selloff from causing a broader financial crisis, especially in pension funds that had loaded up on derivatives as part of a strategy known as liability-driven investment.

The International Monetary Fund, which has criticized the tax plans, also urged the U.K. government to avoid a fiscal stimulus at a time the central bank is hiking interest rates to corral inflation. “Fiscal policy should not undermine monetary policy,”

Kristalina Georgieva,

managing director of the International Monetary Fund, said Thursday, when asked about the situation in the U.K. “So don’t prolong the pain and make sure actions are coherent and consistent.”

U.K. Prime Minister Liz Truss defended her economic plans after her​ government’s​ tax cuts caused turmoil in ​financial​ markets. She was addressing Conservative Party members in her first conference speech as leader. Photo: Paul Ellis/AFP via Getty Images

This week, the Bank of England made it clear it wouldn’t continue to support the bond market past this Friday, a deadline that may have raised the pressure on the government to address some of the markets’ underlying concerns about the sustainability of U.K. finances.

“If they walk away and try to come up with a different, more credible fiscal policy package, you can certainly see sterling bounce back more,” said Kit Juckes, chief foreign-exchange strategist at Société Générale. Others said it could ease pressure on the Bank of England to raise interest rates as aggressively.

But Mr. Juckes and others said that even if the administration reversed course on the tax cuts, it would take time to rebuild confidence in U.K. markets and policy makers. “It’s better than stubbornly going ahead. But you can’t fully put Humpty Dumpty back together again,” he said.

Pressure grew on the government after Ms. Truss appeared to rule out any spending cuts to help fund the plan, which the Institute for Fiscal Studies think tank estimates will require around £60 billion in additional revenue or spending cuts to fully fund the package.

“I’m not planning public spending reductions,” Ms. Truss said on Wednesday. Her spokesman later declined to comment whether the government might try to generate savings through, for instance, preventing government spending on social security from increasing in line with inflation.

Mel Stride,

the Conservative chairman of the Treasury select committee, urged the government to come up with a “clear change in tack” and take “no chances” to convince financial markets that it is serious about fiscal stability. “There is too much at stake for all of us,” he wrote on Twitter.

One option is to go ahead with the increase in corporation tax in April next year, which the government has estimated would save companies nearly £19 billion a year in tax payments. Ms. Truss had previously said such a move would make Britain uncompetitive for business investment.

“I feel it would be wrong, in a time when we are trying to attract investment into our country and at a time of global economic slowdown, to be raising taxes,” Ms. Truss said Wednesday.

The rumors of a change in tack come as the ruling Conservatives lag behind in the polls. A YouGov poll suggests the opposition Labour Party would get 51% of votes versus just 23% for the Conservative Party. They are “circulating a smorgasboard of names re who should replace Truss,”

Nadine Dorries,

a former cabinet minister and Truss supporter, tweeted.

But lawmakers are leery about replacing Ms. Truss given she only came into office at the beginning of September. Removing her would be a “disastrously bad idea,” the U.K. Foreign Secretary James Cleverly said Thursday.

Junking the tax plan, and Mr. Kwarteng, may be enough to ensure Ms. Truss’s political survival for now, said

Tim Bale,

a professor at Queen Mary University of London. “She would be given a chance,” he said. However, he added, it would leave her denuded of any political authority and at the mercy of the whims of the Conservative Party.

Write to Max Colchester at [email protected], Caitlin Ostroff at [email protected] and Chelsey Dulaney at [email protected]

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