Reports that Chancellor Rachel Reeves has dropped plans for what would have been a manifesto breaking income tax rise in the Budget has unnerved financial markets – with a possible impact on mortgage costs
Government borrowing costs jumped and more than £26billion was wiped off the FTSE 100 on the back of Labour’s apparent income tax U-turn.
Reports that Chancellor Rachel Reeves and PM Keir Starmer have dropped plans to increase the tax, which would have broken an election manifesto promise, spooked investors who had assumed it was all-but a done deal following recent speculation.
It is understood Ms Reeves shelved her manifesto breaking income tax plan after receiving better than expected forecasts from the Office for Budget Responsibility. Yet while it would amount to a boost for the Chancellor, the uncertainty over the policy unsettled financial markets.
The yield – or rate – on 10 year UK government gilts rose to 4.57% in early trading on Friday – the biggest rise since July – before easing to around 4.50% Longer 30 year gilts reached 5.32%. Gilts are like IOUs which are issued by the government in order to borrow money for spending commitments beyond what it gets in taxes.
Ms Reeves has vowed to drive down interest payments on the government’s debt mountain, which are expected to cost more than £110billion this year alone.
Higher gilt yields also threaten to put upward pressure on fixed rate mortgage costs, for those taking out a new deal or remortgaging. Dan Coatsworth, head of markets at broker AJ Bell, explained: “They are used as a benchmark by lenders when pricing long-term products. The situation is bad news for mortgage lenders as pricier home loans could make it more challenging for certain people to get on the housing ladder. That explains the sell-off in banking shares including Lloyds and NatWest as well as housebuilders Berkeley, Barratt Redrow and Persimmon.”
The U-turn also unnerved financial market, with the FTSE 100 index of the UK’s biggest listed companies tumbling by around 120 points., its biggest one day drop since April. Meanwhile, the pound was down 0.5% against the US dollar.
The Treasury will be closing watching what happens to gilt yields – as well as the value of the pound – as the day progresses to gauge the all-important market reaction to the looming Budget on November 26. It sought to calm markets, saying the Chancellor would deliver a Budget that “takes the fair choices to build strong foundations to secure Britain’s future.”
Nigel Green, chief executive of financial advisory deVere Group, said: “This is exactly how credibility shocks begin. “Gilts are sliding, borrowing costs are climbing, and sterling is weakening because markets fear the government is improvising. There’s nothing investors hate more than indecision disguised as strategy.” He continues: “The reaction is unmistakable. Bond traders are telling the Treasury that they will not tolerate mixed signals. They saw what happened during the Truss turmoil and they’ll not wait politely for clarity. They’re pricing risk in real time.”
Hal Cook, senior investment analyst at Hargreaves Lansdown, said: “The news that Labour may be U-turning on their planned income tax increases has sparked a wide ranging sell off in gilts this morning. Investors have been worried about the UK’s deficit for some time, which has pushed gilt yields higher, particularly longer-dated yields.
“Since the start of October, these had been falling, partly linked to the expectation that the upcoming Budget would have a meaningfully positive impact on the long-term debt dynamics for the UK. Increases in tax are deemed to be a big part of the plan to tackle the deficit. So, the news that the likely income tax rises have been scrapped hasn’t gone down well with gilt investors.”
But he also cautioned: “As is often the case with quick reaction to surprising news, it’s likely that these moves are over-reactions and yields definitely have potential to come back down from here. Just because Labour may no longer be planning on increasing income tax, we don’t yet know what they may plan to do instead. Government bond markets definitely have the power to keep government budgets in check, as we saw in the UK with the Truss mini-Budget in 2022 and in the US around Liberation Day earlier this year. Watch this space.”
The FTSE 100 had already taken a dive on Thursday after official figures showed a slowdown in UK economic growth in the three months to September. The index – which reached record highs earlier in the week – had been flirting the milestone 10,000 market, delivering a boost to those shares in those companies on it, whether directly or indirectly through funds.
Richard Hunter, head of markets at the online platform Interactive Investor, said: “Despite the persistent weakness of the last couple of trading sessions, the FTSE100 remains ahead by 18.7% in the year to date, and in terms of valuations such a performance could yet tempt some buying on the dip for the steeliest of investors.”
It comes amid separate reports that the Office for Budget Responsibility will tell Ms Reeves she will have a Budget black hole of around £20billion.