Government borrowing costs surged and over £26 billion was wiped off the FTSE 100 as a result of the Labour Party’s apparent reversal on income tax plans. News that Chancellor Rachel Reeves and Prime Minister Keir Starmer have decided against raising taxes, breaking an election pledge, rattled investors who had anticipated the tax hike following recent speculation.
Reeves reportedly abandoned the income tax proposal after receiving more positive forecasts from the Office for Budget Responsibility. While this development could benefit the Chancellor, the uncertainty surrounding the policy unsettled financial markets.
The yield on 10-year UK government gilts rose to 4.57% in early trading on Friday, the largest increase since July, before moderating around 4.50%. Meanwhile, longer 30-year gilts climbed to 5.32%. Gilts, essentially IOUs issued by the government to raise funds for expenditures exceeding tax revenue, are critical in financial operations.
Reeves aims to reduce interest payments on the government’s substantial debt, projected to exceed £110 billion this year alone. Higher gilt yields may also push up fixed-rate mortgage expenses for new borrowers or those refinancing, impacting housing affordability.
The U-turn unsettled financial markets, with the FTSE 100 index plunging about 120 points, marking its most significant single-day decline since April. Concurrently, the pound depreciated by 0.5% against the US dollar.
Market watchers, including Nigel Green of deVere Group and Hal Cook of Hargreaves Lansdown, expressed concerns over the potential impact of the tax policy shift on gilt yields and market stability. The Treasury is closely monitoring market responses as the Budget approaches, emphasizing the importance of prudent fiscal decisions for the nation’s future.
Amid the turmoil, reports suggest a looming £20 billion budget shortfall, adding to the economic challenges facing the government. Despite recent setbacks, the FTSE 100 has seen substantial gains this year, hinting at potential opportunities for savvy investors amidst market fluctuations.