UK bond markets took fright on Friday after it emerged that Rachel Reeves had ditched plans for a manifesto-busting increase in income tax at this month’s autumn budget.
On a day of choppy trading in the City, the cost of UK government borrowing rose by the most in a single day since early July, when a tearful appearance by Reeves in parliament spooked investors.
The yield – in effect the interest rate – on 10-year government bonds, which are known as gilts, jumped by more than 0.13 percentage points to trade at about 4.575%, the highest level in a month.
The pound also sold off against the US dollar on the foreign exchange markets, dropping by about 0.3% to trade at $1.3155, reflecting mounting investor unease over the chancellor’s make-or-break budget in less than two weeks’ time.
Amid a sell-off in financial markets around the world driven by fears in the US economy, the FTSE 100 closed down more than 1% at 9,698.
City investors had grown increasingly comfortable ahead of Reeves’s tax and spending set-piece after the chancellor indicated that she was willing to breach Labour’s manifesto commitments to plug a potential shortfall in the government finances of up to £30bn.
However, it emerged late on Thursday that Reeves was set to abandon plans for an increase in income tax. First reported by the Financial Times, it came amid bitter infighting within Labour ranks and the threat that manifesto-busting measures could provoke a backbench rebellion.
Earlier this week allies of Keir Starmer warned that he would fight any leadership challenge, with some pointing to the health secretary, Wes Streeting, as a potential challenger – which he publicly denied.
“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,” said Andrew Wishart, a senior UK economist at Berenberg bank.
“The risk is that the Labour party replaces Keir Starmer and Rachel Reeves with a duo positioned further to the left on the economic policy spectrum and less committed to fiscal sustainability.”
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City investors had been looking for the chancellor to break with the commitments to rebuild at least £20bn of headroom against her self-imposed fiscal rules, which require day-to-day spending to be matched by receipts in the fifth year of forecasts from the Office for Budget Responsibility (OBR).
It comes amid the exchange of forecasts between the Treasury and its tax and spending watchdog before the 26 November budget, which includes the chancellor updating the OBR on the measures she is likely to announce.
Ruth Curtice, the chief executive of the Resolution Foundation and a former Treasury tax and spending official, said it was normal for the OBR’s forecasts to change in the run-up to the budget. However, she said “excessive levels of kite flying” were fuelling market volatility.
“It is not normal for so much of that to be laid bare in public,” she said. “The market moves this morning and in recent weeks suggest a serious look should be taken at the approach to market-sensitive forecast information.”
