UK government bonds fell sharply on Friday as Rachel Reeves ditched plans to raise income tax in this month’s Budget.
Gilts sold off despite efforts by the Treasury to signal that the planned increase in tax rates had been pulled because of more positive fiscal forecasts.
The 10-year yield was 0.1 percentage points higher on the day on Friday afternoon at 4.54 per cent, after earlier rising as much as 0.13 points. Yields move inversely to prices.
According to people familiar with the matter, the UK government ditched plans to raise income tax rates after an improved fiscal forecast from the Office for Budget Responsibility.
The OBR published a timeline on Friday morning confirming that it submitted a “later reading” of government indicators to the Treasury on Monday, including recent economic and public sector finance data.
However, Paul Johnson, former director of the Institute for Fiscal Studies, said the government should already have factored in wage growth — a key contributor to the improved forecast — by the end of last month.
“I can’t see a good reason to change it in the last month . . . from the previous forecast,” he said.
The U-turn comes days after a leadership crisis threatened to engulf Sir Keir Starmer’s premiership.
However, Downing Street officials insisted the Budget had not been rewritten to shore up Starmer’s political standing.
Given the better than expected OBR forecasts, a previously estimated hit to the public finances of up to £30bn is now closer to £20bn, according to the people familiar with the matter.
The chancellor wants to fill that hole and also add at least £5bn to her previous fiscal headroom of £9.9bn, the people said.
This would leave her with a buffer against her key fiscal rule of at least £15bn.
The FT on Thursday first reported that the government had abandoned plans to raise income tax rates amid fears it would anger voters and further antagonise mutinous Labour MPs.
People familiar with the matter said Reeves would instead rely heavily on what has been dubbed the “smorgasbord” approach of increasing a range of narrowly drawn taxes.
Reeves has also decided against introducing an expected levy on individuals who operate through limited liability partnerships, according to people briefed on the plans.
The chancellor has also walked back proposals for a new tax on wealthy Britons relocating to low-tax jurisdictions, the people said.
Investors said Friday’s gilt sell-off reflected concerns in the bond market over the government’s credibility after being “led up the garden path” on a potential income tax hike that was then junked.
“Fundamentally it does not seem as though Starmer and Reeves have got enough control or power in their party to put through difficult decisions,” said John Stopford, head of multi-asset income at asset manager Ninety One.
