Financial markets grow fretful after reports of UK government abandoning income tax hike

British financial markets reacted with uncertainty Friday as reports emerged that Treasury chief Rachel Reeves has abandoned plans to increase income taxes in the upcoming budget, scheduled for November 26. The news triggered immediate market jitters, with the pound falling 0.4% to $1.3137 and the yield on the UK’s 10-year government bonds rising by 0.13 percentage points to 4.57% by late afternoon in London.

The rising bond yield signals growing investor concern about Britain’s fiscal outlook, as markets had been preparing for tax increases to address the nation’s public finances. According to Deutsche Bank’s chief UK economist Andrew Goodwin, this development has significant implications for market confidence.

“This episode demonstrates the importance of the budget as a test of market confidence in the UK government’s fiscal approach,” Goodwin noted. “If the cause is political, with the government concerned about how voters will react to income tax hikes, it may strengthen perceptions that the government lacks the appetite to take tough fiscal decisions.”

The apparent reversal comes at a critical juncture for Prime Minister Keir Starmer’s Labour government, which took office just over a year ago but is already struggling in opinion polls. Starmer’s personal approval ratings have dipped into negative territory, creating political pressure that may have influenced the reported decision on tax policy.

An income tax increase would have represented a significant breach of Labour’s manifesto pledges from the 2023 election campaign, when the party promised not to raise taxes on working people. This campaign promise helped Labour secure a decisive victory after 14 years of Conservative rule.

In recent weeks, Reeves had been carefully preparing the public for potential tax increases. As recently as Monday, she warned that without breaking manifesto commitments on taxes, the government would face making “deep cuts” to public investment. The apparent U-turn suggests political calculations may have outweighed fiscal considerations.

Health Secretary Wes Streeting, reportedly aligned with Starmer’s inner circle, publicly welcomed the news that income tax increases would be abandoned. “It is really important that we keep the promises that we made to the public at the last general election,” Streeting said, highlighting concerns about further eroding public trust in political institutions.

The change in direction may have been influenced by updated economic forecasts from the independent Office for Budget Responsibility. These revised figures potentially show stronger wage growth in recent months, which would naturally increase tax revenue without the need for rate increases.

Britain’s economy, the sixth-largest globally, has been underperforming its long-term average since the 2008-2009 financial crisis. The Labour government, elected in July 2024 with promises to revitalize economic growth, has faced persistent challenges in delivering on this central mission.

The economic environment remains challenging, with inflation still elevated above target and economic growth sluggish. These factors have complicated the government’s efforts to improve public services, which suffered significant strain during the pandemic and subsequent cost-of-living crisis.

Financial analysts now await the November 26 budget with heightened interest, wondering what alternative measures Reeves will propose to address fiscal shortfalls without raising income taxes. The government faces the difficult balancing act of maintaining market confidence while adhering to election promises and addressing the UK’s economic challenges.

The budget will be viewed as a definitive statement of the new government’s economic priorities and its willingness to make difficult decisions in a challenging fiscal environment. For now, markets remain cautious as investors await clarity on the government’s plans to address Britain’s economic challenges.