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

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LONDON (AP) — British financial assets were under pressure Friday on growing speculation that the Labour government has ditched plans to raise income taxes in a crucial budget at the end of the month.

Treasury chief Rachel Reeves was clearly considering becoming the first Chancellor of the Exchequer in 50 years to increase the basic rate of income tax. But widespread reports say she has decided against it, causing investors to grow nervous over the uncertain budget process.

By late afternoon London time, the pound was 0.4% lower at $1.3137, while the yield, or interest rate, on the British government's benchmark 10-year bond was up 0.13 percentage point at 4.57%.

The increase in the yield is particularly illustrative as it shows that investors are demanding a bigger return on their bond holdings, a clear sign that they are fretting about the outlook for the U.K.'s public finances and the government's ability to act boldly over fears higher income taxes would anger voters.

“This episode demonstrates the importance of the budget as a test of market confidence in the U.K. government’s fiscal approach,” said Deutsche Bank's chief U.K. economist, Andrew Goodwin.

“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,” he added.

It’s a high-stakes time for the government, which is languishing in the opinion polls barely a year-and-a-half after coming to power and Prime Minister Keir Starmer’s favorability ratings deep in negative territory.

Reeves had been expected to hike the main income tax rate in her budget on Nov. 26, which would break Labour's central pledge in its manifesto ahead of last year's general election, which saw the party sweep back to power after 14 years.

Reeves has been laying the ground for tax rises over recent weeks, and as recently as Monday, she indicated that the alternative to breaking the manifesto pledge would be “deep cuts” to public investment.

Wes Streeting, the health secretary who earlier this week was being briefed by supposed allies to Starmer, welcomed reports that the income tax has been abandoned, partly because it would have further undermined trust in politics as a whole.

“It is really important that we keep the promises that we made to the public at the last general election,” he said.

In recent days, Reeves received updated forecasts from the independent Office for Budget Responsibility. An improvement would lessen the need for Reeves to raise as much as money as she had been planning for, and experts say stronger wage growth in recent months will mean higher taxes coming into the Treasury.

The British economy, the sixth-largest in the world, has underperformed its long-run average since the global financial crisis of 2008-2009, and the center-left Labour government elected in July 2024 has struggled to deliver the economic growth it said was its driving mission.

Inflation remains stubbornly high and growth sluggish, frustrating efforts to repair tattered public services and ease the cost of living.