Back in June, it was the U-turn on welfare that raised eyebrows. Now it’s a perceived volte-face on tax.
After weeks of suggestions that income tax may have to rise in the forthcoming budget, government sources have confirmed that Chancellor Rachel Reeves will do no such thing.
The government is flip-flopping in a febrile environment. Markets are sensitive to levels of government debt, which climbed by 17.9% between 2019 and 2024.
In the context of an ageing population, slow growth and comparatively high inflation, there are concerns that UK debt is on an unsustainable path. Markets want consolidation – for the chancellor to get a grip on tax and spending.
Ms Reeves, with her insistence on iron-clad fiscal rules, promised discipline. But flip-flopping doesn’t look like discipline. Markets are letting their thoughts be known – and their thoughts matter because the government borrows from them.
Government bond yields, the interest rate demanded on UK debt, jumped amid fears that the government is not prepared to face down opposition from its own backbenchers, from political opponents or the public.
The 30-year gilt was up 16 basis points after its worst day since July, when the chancellor was seen crying in the Commons. The 10-year gilt was up 13 points.
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Borrowing costs are already costing the country more than £100bn a year – about 10% of total spending. The more money the government is spending on interest, the less flexibility it has to spend more in other areas, like schools or hospitals.
It appears that Ms Reeves has changed tack because official forecasts from the Office for Budget Responsibility (OBR), whose forecasts underpin the budget, show the fiscal black hole is closer to £20bn, rather than the £30bn first feared. It means she can take less radical steps to raise money.
Markets are pleased that the chancellor is sticking to her rules, but they are viewing this move with scepticism.
Many view the OBR forecasts as overly optimistic. These are smaller tax rises to tackle a smaller problem on paper, but is what’s written on that paper credible?
Andrew Goodwin, of Oxford Economics, said: “If investors suspect the government is leaning on convenient assumptions, they may assume more trouble ahead – and yields could rise further.”
Then there’s the speculation over which taxes could rise. Markets have a clear preference towards income tax because, unlike the increase in national insurance contributions on businesses in the last budget, it’s not inflationary.
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And alternative sources, such as tweaks to stamp duty or EV taxes, are less dependable revenue raisers. “Avoiding the politically sensitive income tax lever implies less willingness to tackle the structural deficit later,” said Gordon Shannon, of TwentyFour Asset Management.
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Traders are eyeing the long-term trajectory of the UK, and they are bristling at short-term fixes and tweaks that don’t address the fundamental fiscal position.
There are those in policy who are also frustrated at the approach, which has seen the government pick and drop policies to meet fiscal rules by fine margin.
It is difficult to find any political vision in it all.
