Market Turmoil Follows Chancellor's Surprise Tax Reversal
Borrowing costs for the UK government have increased sharply and the pound has fallen following Chancellor Rachel Reeves' extraordinary last-minute decision to abandon plans to raise income taxes in the upcoming budget. The dramatic U-turn, confirmed by government sources, represents a significant shift in fiscal policy despite weeks of warnings about the need for difficult tax decisions.
Immediate Financial Fallout
Financial markets reacted swiftly to the news, with interest rates on government bonds rising by more than 10 basis points in early trading. This puts them on track for their worst performance since 2 July, when investors responded to Reeves' emotional appearance in the House of Commons. Meanwhile, the pound dropped 0.5% against the dollar, reflecting market uncertainty about the government's fiscal strategy.
The reversal comes despite the chancellor having spent weeks preparing Labour MPs and the public for the possibility of breaking manifesto pledges on tax to avoid a market meltdown. Reeves had even invited external experts to brief Labour backbenchers on the difficult decisions they would need to defend, telling BBC Radio 5 Live on Monday that sticking with manifesto commitments would require "deep cuts in capital spending."
Political Calculations and Expert Warnings
Sources indicate that Reeves and Prime Minister Keir Starmer made the final decision on Wednesday - the latest possible moment to make major changes to budget measures - choosing instead to focus on a series of smaller tax rises rather than increasing headline income tax rates. The decision came during a turbulent week for the prime minister, who has faced accusations of allowing allies to brief against Health Secretary Wes Streeting.
Kathleen Brooks, research director at brokerage XTB, commented: "Bond market volatility is not what the chancellor wants to see with less than two weeks to go before the budget. Essentially, the bond market is warning the chancellor that she cannot merely tax the 'rich' to fund her lavish spending pledges. Either she broadens the tax base, or she cuts spending."
Economists have raised concerns about the alternative approach. Ben Zaranko of the Institute for Fiscal Studies highlighted several risks on social media platform X, noting that smaller tax increases could result in more uncertain revenues, greater potential for damaging economic impacts, and likely dissatisfaction among bond market investors who had been expecting an income tax rise.
The government appears to have changed its messaging, with Culture Secretary Lisa Nandy telling BBC Breakfast that the chancellor takes her promises seriously and "won't play fast and loose with people's money." The decision leaves the government searching for alternative ways to address a budget shortfall estimated at approximately £30 billion.
