British Pound Soars as Truss Cans Tax Cut Plan. Will GBP/USD Extend its Recovery?

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  • GBP/USD rallies after the UK government scraps expensive and unfunded plan to cut taxes
  • While the Prime Minister’s credibility has been damaged, investors welcome the move towards a less irresponsible fiscal stance
  • The British pound is also boosted by risk-on mood in global markets and the U.S. dollar’s softer tone in the FX space

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The British pound surged more than 1% at the start of the week amid U.S. dollar weakness and risk-on mood in financial markets. However, most of sterling’s gains could be attributed to idiosyncratic developments on the fiscal front in UK.

On Monday, Prime Minister Liz Truss made a U-turn and scrapped a controversial plan to lower the top rate of income tax that would have benefited mostly high earners. According to Finance Minister Kwasi Kwarteng, the proposal has become a distraction, preventing the administration from focusing on the most important challenges facing the economy.

Whatever the reasoning, markets welcomed the news to ditch the expensive and unfunded scheme as the move will ease pressure on the budge, reducing the likelihood of the deficit ballooning to unsustainable levels in the coming quarters.

Although the Prime Minister’s credibility has been damaged, the shift to a less irresponsible fiscal stance should be positive, on net, for the pound. This means that GBP/USD may still have gas in the tank to run higher and extend its recovery in the near term, especially considering how oversold the currency became in recent weeks.

However, the sterling rebound thesis also hinges on the U.S. dollar maintaining a softer tone in the FX space. To provide some color, the DYX index has retreated in recent days, dragged lower by falling U.S. Treasury yields on the resurgence of bets that the Fed could pivot soon to avoid an economic accident amid heightened stress in financial markets.

It is hard to say for certain how events will unfold, but if Fed officials come out and pour cold water on this narrative in the coming days, the mood could sour very quickly again, bolstering the greenback across the board. For context, the U.S. dollar tends to outperform high-beta currencies in times of elevated uncertainty and turbulence, to the extent that it trades as a risk-off proxy.

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After the recent rally, GBP/USD has moved towards the upper boundary of a near-term rising channel at 1.1350, a key resistance to keep an eye on this week. If the bulls manage to clear this hurdle decisively in the coming sessions, buying interest could accelerate, paving the way for a challenge of the 1.1470 area. On further strength, the focus shifts higher to the 1.1600 psychological handle. On the flip side, if sellers reemerge and trigger a bearish reversal from current levels, initial support appears at 1.1225. If this floor is breached, we could see a drop towards 1.1025, followed by 1.0920.


GBP/USD Chart Prepared Using TradingView

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—Written by Diego Colman, Market Strategist for DailyFX

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