Government borrowing costs surged and over £26 billion was erased from the FTSE 100 due to the apparent reversal of the Labour Party’s income tax stance. News that Chancellor Rachel Reeves and PM Keir Starmer decided to abandon the tax hike plan, which would have violated a campaign promise, rattled investors who had anticipated its implementation based on recent rumors.
Reports indicate that Ms. Reeves set aside her proposal to breach the manifesto after receiving more favorable forecasts from the Office for Budget Responsibility. While this could benefit the Chancellor, the uncertainty surrounding the policy unsettled financial markets.
The yield on 10-year UK government gilts spiked to 4.57% in early trading on Friday, marking the largest increase since July before stabilizing around 4.50%. Longer-term 30-year gilts reached 5.32%. Gilts function as government-issued IOUs to secure funds for expenditures beyond tax revenues.
Ms. Reeves pledged to reduce interest payments on the government’s substantial debt, projected to exceed £110 billion this year alone. Elevated gilt yields also pose a risk of elevating fixed-rate mortgage expenses for new borrowers or those refinancing. This development prompted a sell-off in banking shares, including Lloyds and NatWest, along with housebuilders like Berkeley, Barratt Redrow, and Persimmon.
The U-turn unsettled financial markets, with the FTSE 100 plummeting about 120 points, marking its most significant single-day decline since April. Concurrently, the pound depreciated by 0.5% against the US dollar.
The Treasury closely monitors gilt yields and the pound’s value throughout the day to assess market reactions to the impending Budget on November 26. Seeking to reassure markets, the Treasury affirmed that the Budget would prioritize equitable measures to fortify Britain’s future.
Nigel Green, CEO of financial advisory deVere Group, cautioned that the recent developments could trigger credibility shocks. He highlighted that rising borrowing costs, sliding gilts, and weakening sterling signal market concerns over government decision-making. Bond traders are conveying their intolerance for mixed signals, emphasizing the need for clarity to mitigate risk.
Hal Cook, a senior investment analyst at Hargreaves Lansdown, noted that the potential abandonment of income tax increases by Labour led to a widespread gilt sell-off. Investors, concerned about the UK’s deficit, had pushed gilt yields up, especially for longer maturities. The unexpected policy shift raised uncertainty about the government’s deficit reduction strategy.
Despite the recent market turbulence, the FTSE 100 remained up by 18.7% year-to-date, attracting investor interest in potential buying opportunities. The economic landscape is further complicated by projections of a £20 billion Budget shortfall, as indicated by the Office for Budget Responsibility.