Key events
Kiran Stacey
Full story: UK borrowing costs up after markets spooked by Reeves’s income tax U-turn
Borrowing costs for the UK have increased and the pound fallen after the chancellor’s extraordinary last-minute decision to ditch tax-raising plans in the upcoming budget.
Interest rates on government bonds rose by more than 10 basis points in early trading, putting them on track for their worst day since 2 July, when investors responded to a tearful appearance by Rachel Reeves in the House of Commons chamber. The pound meanwhile dropped 0.5% against the dollar.
The market reaction came after government sources confirmed Reeves had dropped plans to raise income taxes to help close a budget shortfall of about £30bn.
The U-turn came despite weeks of warnings to Labour MPs and the wider public that the chancellor might have to break her manifesto pledges on tax to avoid a market meltdown.
Reeves has been working on plans for weeks to raise income taxes at the budget, despite having promised not to do so before the election.
The chancellor has even invited external experts to brief Labour backbenchers on the difficult decisions they are likely to have to defend.
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The pound is now trading down just 0.24% versus the dollar at around £1.3159.
The 10-year gilt yield is now up 0.06 percentage points at 4.49%
Across long-dated government bonds, the 20-year gilt yield is now up just 0.085 percentage points at 5.193% while the 30-year gilt yield is up 0.091 percentage points at 5.324%.
Pound and gilt losses ease on reports of better-than-expected fiscal forecast
We’re now seeing some easing of losses on both the pound and UK gilts, which seem to have followed this Bloomberg report suggesting Reeves has received stronger readings from the Office for Budget Responsibility (OBR).
It suggests the improved forecasts would leave the fiscal hole at a smaller £20bn, versus previous expectations of £35bn
Bloomberg reports:
Chancellor of the Exchequer Rachel Reeves has been able to drop plans to raise income taxes because she received an improved fiscal forecast from the UK’s budget watchdog, people familiar with the matter said.
The latest update from the Office for Budget Responsibility moved in a significantly more favorable direction due to the strength of government receipts and stronger wage performance, the people said, asking not to be named discussing sensitive matters.
A fiscal hole predicted to be as wide as £35 billion ($46 billion) is in fact now closer to £20 billion, they said.
The report adds that the expected productivity downgrade from the OBR has been partially offset by other factors, and that “major tax rises” are still expected to fill the remaining hole in the public finances.
Treasury issues statement to try calm budget jitters
HM Treasury has been trying to quell concerns over the reports over the income tax u-turn overnight, issuing a fresh statement to media this morning in response.
A Treasury spokesperson said:
We do not comment on speculation around changes to tax outside of fiscal events.
The chancellor will deliver a Budget that takes the fair choices to build strong foundations to secure Britain’s future.
The chancellor’s income tax rate hike reversal may be interpreted as the Labour government prioritising their public popularity ratings, and stability of the political party, above the need to stabilise the UK’s finances, analysts have warned.
Lee Hardman, senior currency economist at MUFG, says:
The initial negative reaction for the pound today … is an indication that the government’s fiscal tightening plans are viewed as less credible by market participants without an income tax hike.
The decision to drop the income tax hike could be viewed as the Labour leadership prioritising their popularity with the public and the stability of the Labour party over doing what is best to restore confidence in the public finances.
Nevertheless, we still expect the package of fiscal tightening measures to put a dampener on economic growth in the UK and create more room for the BoE to lower rates further.
The releases this week of the weaker UK labour market and GDP reports have reinforced negative sentiment towards the pound in the near-term.
This has all left investors ‘“scratching their heads” and expecting a “death by a thousand cuts” kind of budget, if Reeves hopes to find money to fund key policies including ramped up UK defence commitments, according to XTB’s research director Kathleen Brooks:
The u-turn on income tax rises, while better for growth in a service-based economy, does leave markets scratching their heads about how to fund scrapping the two child benefit cap, the ballooning benefits bill and Britain’s defense commitments.
Instead, the budget is likely to be death by a thousand cuts, in the form of hundreds of tax rises announced on the 26th, which one source called a smorgasbord of fiscal choices for the chancellor.
Kathleen Brooks, research director at XTB notes that Reeves’ change of plans is essentially leaving policy pledges unfunded, with the chancellor now faced with finding an alternative way to raise money to fill an estimated £30bn fiscal hole in (checks watch) less than 2-weeks.
Brooks says:
This also means that the chancellor has signalled billions of unfunded spending pledges, which the bond market is not fond of.
Hence why yields are rising sharply across the curve. The 10-year yield is higher by 10bps, while the 2-year yield is higher by 9bps at the open. 30-year yields are taking an even bigger hit and are higher by 12bps.
Bond market volatility is not what the chancellor wants to see with less than two weeks to go before the budget.
Essentially, the bond market is warning the chancellor that she cannot merely tax the ‘rich’ to fund her lavish spending pledges. Either she broadens the tax base, or she cuts spending.
Sterling and FTSE 100 slide on budget jitters
The pound has taken a hit, falling nearly 0.5% on the dollar to $1.3129 and weakening against the euro.
Meanwhile the FTSE 100 has lost about 1.1%, with its listed banks – often a bellwether for the UK economy – having taken a tumble.
Barclays, Lloyds and NatWest all have fallen 3.1-3.5% after the market open.
UK gilt yields rise as investors digest Reeves income tax u-turn
We’re getting some market moves as investors digest Rachel Reeves’ change in plans on income tax ahead of the autumn budget.
In the bond market, the yield on the UK’s 30-year gilt is up 12 basis points, suggesting there is a perception of growing risk to the fiscal position.
The yield on the 20-year gilt, meanwhile, was sitting at 5.225%, also up 12 basis points on the day
Reuters says this is putting long-dated gilts on track for their worst day since July 2, when a Reeves’ tearful appearance in parliament spooked investors.
Culture secretary Lisa Nandy has weighed in on the chancellor’s plans to drop awhat would have been a manifesto-breaking income tax hike this morning.
Nandy told Sky News that Rachel Reeves remains “completely focused” on the public interest, but added it would not be “helpful or right” to speculate about what is in the November 26 budget.
When asked if the latest reported u-turn made it look like the Labour government’ didn’t know what it was doing, Nandy said:
I’ve known the Chancellor well for 15 years now, and I can tell you that she is solely and fiercely focused on the challenges facing the country and doing what is in the best interests of the country.
She’s never been shy of facing people down in order to do that in opposition and in government.
Over the course of the last few weeks, obviously I’ve had some discussions with her and her team about measures in the budget that may affect my department, proposals that we’re making, and discussions that ordinarily happen across government, and in every one of those discussions, it’s been the public interest that she’s completely focused on.
Introduction: Reeves backs off income tax hike; China sees further factory slowdown
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
We start the day with a u-turn from the Labour government, with chancellor Rachel Reeves set to abandon a plan to raise income tax in her 26 November budget.
The chancellor had previously informed the budget watchdog of plans to raise income tax – breaking one of Labour’s key manifesto pledges. But the Guardian has since confirmed that those main measures have been ditched.
The Financial Times, which first broke the story, has reported that Reeves may instead look at thresholds at which people pay tax (which is likely to be seen as an income tax rise by stealth).
However, Reeves is now likely to have to rely on a string of small tax hikes in order to fill what is expected to be a multibillion-pound “hole” in the public finances, sparked by weaker productivity and u-turns on other policies including cuts to the winter fuel allowances and disability benefits.
On the other side of the world, China is reeling as freshly released data showed factory output and retail sales grew at their weakest pace in over a year in October.
Industrial output grew 4.9% year-on-year in October, according to China’s National Bureau of Statistics (NBS) marking the weakest annual pace of growth since August 2024. That was down from a 6.5% rise in September, and fell short of the 5.5% forecasted in a Reuters poll.
Meanwhile, retail sales – a key sign of consumer confidence and spending – expanded 2.9% last month, also marking the worst pace since August last year that was down from a 3.0% rise in September.
The figures will pile further pressure on policymakers in Beijing to do more to support China’s export-driven economy, as they face further risks from a trade war with the US and weak domestic demand.
On top of the agenda items below, we’re also expecting a Q2 update from Jaguar Land Rover later this morning. Stay tuned!
