There is international pressure on Kwasi Kwarteng to change course after his mini-budget spooked the markets with its package of tax cuts and increased borrowing.
In an extraordinary statement, the International Monetary Fund (IMF) said it was “closely monitoring” developments and urged the Chancellor to “reevaluate the tax measures”.
It warned the current plans, including the abolition of the 45p rate of income tax for people on more than £150,000, are likely to increase inequality.
The move came as the Bank of England signalled it was ready to ramp up interest rates to shore up the pound and guard against increased inflation.
The Chancellor insisted he was “confident” his tax-cutting strategy will deliver the promised economic growth.
After a day of turmoil in the markets on Monday which saw sterling slump to a record low against the dollar, the Chancellor sought to reassure City investors he has a “credible plan” to start reducing the UK’s debt mountain.
But the IMF said in a statement: “We understand that the sizeable fiscal package announced aims at helping families and businesses deal with the energy shock and at boosting growth via tax cuts and supply measures.
“However, given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy.
“Furthermore, the nature of the UK measures will likely increase inequality.”
It urged Mr Kwarteng to change course when he comes back to Parliament in November with another package, intended to show how he will get the public finances back on track.
“The November 23 budget will present an early opportunity for the UK Government to consider ways to provide support that is more targeted and reevaluate the tax measures, especially those that benefit high income earners,” the IMF said.
In response to the criticism a Treasury spokeswoman said: “We have acted at speed to protect households and businesses through this winter and the next, following the unprecedented energy price rise caused by (Vladimir) Putin’s illegal actions in Ukraine.”
The Government was “focused on growing the economy to raise living standards for everyone” and the Chancellor’s statement on November 23 “will set out further details on the government’s fiscal rules, including ensuring that debt falls as a share of GDP (gross domestic product) in the medium term”.
The Bank of England’s chief economist Huw Pill warned they “cannot be indifferent” to the developments of the past days – seen as a signal the cost of borrowing will have to go up to protect the pound and keep a lid on inflation.
“It is hard not to draw the conclusion that all this will require significant monetary policy response,” Mr Pill said in a speech to the Barclays-CEPR International Monetary Policy Forum.
“We must be confident in the stability of the UK’s economic framework.”
After two days of big changes, the pound settled down on Tuesday, trading at around 1.08 dollars for most of the day, deviating only briefly with a two cent drop.
London’s top stock index, the FTSE 100, was also subdued for most of the day.
But European markets dropped heavily just before close as the price of gas spiked.
The FTSE closed the day down 0.5% on Tuesday afternoon and, worryingly for the Government, gilt yields, reflecting the cost of borrowing by the state, rose 1.6%, more than a quarter higher than just a week ago.
But with some analysts predicting the base rate, currently standing at 2.25%, will have to rise to as high as 6% next year, some lenders began withdrawing mortgage products amid the uncertainty.
The crisis was triggered by Mr Kwarteng’s mini-budget on Friday when he unveiled a massive £45 billion tax cut funded by Government borrowing.
At a meeting on Tuesday with institutional investors, the Chancellor emphasised the importance of the “supply side” reforms ministers will be setting out in the coming weeks to boost growth, including his “Big Bang 2.0” reforms to further liberalise financial market regulation.
“We are confident in our long-term strategy to drive economic growth through tax cuts and supply side reform,” he told them, according to a Treasury readout of the meeting.
His comments came amid reports that Liz Truss had initially resisted moves by the Treasury on Monday to announce the new medium-term fiscal plan in order to calm the markets.
Government sources did not deny the Prime Minister and Chancellor had met to discuss the issue but insisted suggestions it had been an “argumentative” encounter and descended into a “shouting match” were wide of the mark.
Despite a calmer day on Tuesday, many Conservative MPs remain deeply concerned about the political fallout from the tumultuous start to Ms Truss’s premiership.
It is understood that Mr Kwarteng held a call with Tory MPs alongside Chief Secretary to the Treasury Chris Philp, as the Chancellor sought to settle nerves among colleagues after the turbulence of recent days.
With a YouGov poll for The Times showing Labour opening up a 17-point lead, some MPs who did not support her in the leadership contest have privately questioned whether she is up to the job.
Mel Stride, the chairman of the Commons Treasury Committee, who backed Rishi Sunak for the leadership, said the party’s reputation on the economy was “in jeopardy”.
He said the country was in “an extremely difficult situation” with higher borrowing costs than Italy or Greece and that it was essential to rebuild confidence in the wake of the Chancellor’s “unfunded” tax promises.
“That really I think is the part that has spooked the markets, because those tax cuts have got to be paid for,” he told BBC Radio 4’s The World At One.