Financial markets reacted with alarm on Friday after Chancellor Rachel Reeves abruptly abandoned plans for a significant increase in income tax, triggering the sharpest single-day rise in UK government borrowing costs since early July.
Market Turmoil Follows Fiscal Reversal
The yield on 10-year government bonds, known as gilts, surged by more than 0.13 percentage points to reach approximately 4.575%, marking the highest level witnessed in a month. This dramatic movement occurred alongside a sell-off in sterling, with the pound dropping about 0.3% against the US dollar to trade at $1.3155.
This market volatility reflects growing unease among investors regarding the Chancellor's make-or-break autumn budget, scheduled for less than two weeks' time. The widespread nervousness contributed to a broader downturn, with the FTSE 100 index closing down more than 1% at 9,698.
Political Pressure Forces Tax U-Turn
The decision to scrap the proposed income tax rise, first reported by the Financial Times, follows intense internal party conflict and the looming threat of a backbench rebellion against measures that would breach Labour's manifesto commitments.
Andrew Wishart, a senior UK economist at Berenberg bank, commented on the political ramifications: "The income tax U-turn demonstrates a lack of political competence which has probably led investors to increase the probability they attach to a change in the leadership of the Labour party and government." He further warned that the situation raises the risk of the party replacing Keir Starmer and Rachel Reeves with leaders less committed to fiscal sustainability.
Broader Implications for Fiscal Strategy
City investors had previously been reassured by signals that the Chancellor was prepared to break manifesto pledges to address a potential £30 billion shortfall in government finances. They had anticipated measures to rebuild at least £20 billion of headroom against her self-imposed fiscal rules.
The timing of this policy reversal is particularly sensitive, coinciding with the exchange of critical forecasts between the Treasury and the Office for Budget Responsibility (OBR) in the final run-up to the 26 November budget.
Ruth Curtice, Chief Executive of the Resolution Foundation and a former Treasury official, noted that while forecast changes before a budget are normal, the public nature of recent discussions is not. She stated, "It is not normal for so much of that to be laid bare in public. The market moves this morning and in recent weeks suggest a serious look should be taken at the approach to market-sensitive forecast information."
