Reeves accused of ‘rattling the markets’ after income tax U-turn pushes up borrowing costs

Good morning. On Monday last week Rachel Reeves, the chancellor, gave a speech that implied it was all but certain she would break a manifesto promise and raise the main rate of income tax in the budget. Government officials made no attempt to challenge this idea, and some briefings said the decision was “nailed on”.

Only it wasn’t. There has been a U-turn. The news was broken by the Financial Times last night, in a story saying Reeves and Keir Starmer have have “ditched their manifesto-busting plan to increase income tax rates, in a dramatic U-turn ahead of the budget”. The Guardian was soon able to confirm the story and here is our report by Jessica Elgot, Pippa Crerar and Peter Walker.

As the story explains, a U-turn on this scale may be hard to explain.

Downing Street and the Treasury have been preparing the ground for weeks with Labour MPs for a breach of the manifesto. In particular, it has been stressed to Labour MPs that they should not speak out against the budget because of the effect any potential measures might have on the bond markets and the UK’s borrowing costs.

That message to MPs is likely to ring hollow if the chancellor has U-turned after days of internal warfare over a potential challenge to the prime minister’s leadership and the spotlight on briefings against the health secretary, Wes Streeting.

This is all happening less than a fortnight before the budget, which is taking place on Wednesday 26 November.

Here are the main developments on this story this morning.

Lisa Nandy, the culture secretary, has not denied the FT scoop. But, in an interview on Sky News, she rejected suggestions that the reported U-turn made the government look chaotic.

Kemi Badenoch, the Conservative leader, has welcomed the reports saying the proposed rise in income tax has been ditched. On social media, commenting on a link to the FT story, she said:

Good. (If true).

Only the Conservatives have fought Labour off their tax-raising plans. But one retreat doesn’t fix a Budget built on broken promises. Reeves must guarantee no new taxes on work, businesses, homes or pensions -and she should go further by abolishing stamp duty.

We’re getting some market moves as investors digest Rachel Reeves’ change in plans on income tax ahead of the autumn budget.

In the bond market, the yield on the UK’s 30-year gilt is up 12 basis points, suggesting there is a perception of growing risk to the fiscal position.

The yield on the 20-year gilt, meanwhile, was sitting at 5.225%, also up 12 basis points on the day

Reuters says this is putting long-dated gilts on track for their worst day since July 2, when a Reeves’ tearful appearance in parliament spooked investors.

This is from Faisal Islam, the BBC’s economics editor.

Kalyeena has more on this here.

And, in response, the Conservative have accused Reeves of “rattling the markets”. This is from Kevin Hollinrake, the Tory chair.

What Rachel Reeves fails to grasp is that this constant ‘will she, won’t she’ briefing is rattling the markets and undermining business confidence.

It’s bad for growth, bad for investment and bad for jobs.

The country is paying the price for her indecision.

Here is the agenda for the day.

9am: Wes Streeting, the health secretary, takes part in an LBC phone-in.

10am: Peers start the committee stage debate of the assisted dying bill.

11.30am: Downing Street holds a lobby briefing.

Morning: Kemi Badenoch is on a visit in Essex.

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Key events

Treasury considering cutting thresholds for higher rates of income tax in budget, after ruling out basic rate hike

Pippa Crerar, the Guardian’s political editor, says that a combination of better-than-expected fiscal forecasts, and internal opposition – at cabinet level (see 9.59am), not just in the PLP – persuaded Rachel Reeves to drop the plan to raise the basic rate of income tax.

But Reeves may compensate by dragging more people into higher rates of tax, Pippa says.

We’re also hearing that the OBR’s fiscal forecasts are better than expected, as result of stronger wage growth and therefore higher tax receipts.

It means Rachel Reeves doesn’t need to put up basic rate of income tax to fill lower than expected fiscal gap: the politics of that were proving just too hard with disagreement w/in cabinet and anxiety among Labour MPs over manifesto breach.

But – not least because she wants bigger than before headroom to protect against future risks – we’re still expecting chancellor to fill the gap through taxes.

We were already expecting threshold freezes but now reducing thresholds for 40p and 45p rates also an option. Would drag more people into paying higher rates, esp given wage growth. Salary sacrifice schemes also likely to be hit.

Ministers will hope that this will be seen as a fudge of manifesto promise – rather than blatant breach which would have made them first government in 50 years to hike basic rate of income tax.

Cutting the thresholds for the higher and additional rates of income tax would not be an easy political choice for the chancellor. (See 8.57am.) Rightwing papers in particular regularly complain about “fiscal drag”, the process whereby not raising thresholds in line with inflation pulls more people into higher tax brackets. This has affected millions of people because thresholds have been frozen for much of this decade. (In Australia the process is called “bracket creep”, which is more distinctive.) Cutting thresholds would be like fiscal drag on steroids.

‘I’m not in favour of breaking manifesto pledges’ – Streeting suggests Reeves right to ditch budget plan to raise income tax

When Wes Streeting did a media round on Wednesday morning, after No 10 briefing that implicitly accused him of plotting against Keir Starmer, he was mostly supportive of Starmer and the government. But he included some criticism, including a subtle hint than he thought breaking the manifesto promise on income tax would be a mistake.

This morning he has said it out loud. This is what he told listeners during his LBC phone-in this morning when asked about the budget U-turn story.

I’m not in favour of breaking manifesto pledges. I think that trust in politics and politicians is low and it’s part of our responsibility to not only rebuild our economy and rebuild our public services, but to rebuild trust in politics itself.

The fact that the chancellor – and we’re going on speculation here – but the fact that the chancellor was reported as even considering breaking manifesto commitments tells you two things: Firstly, the public finances are under real pressure, and secondly she is fundamentally, unequivocally, committed to her fiscal rules and so therefore she’s got some invidious choices to make, and she’s weighing those up.

I’ve not spoken to the chancellor overnight. I’ve seen the reports this morning that she’s no longer planning to increase income tax.

I think what the news overnight has shown is that people speculate on the budget but ultimately you don’t know what’s in it until the day it’s delivered, and that includes the cabinet, by the way. So we will all have to wait and see.

On this issue, on Wednesday, Streeting certainly gave the impression of being ahead of the curve. That may be one reason why has ended the week as the clear favourite in the betting markets to replace Keir Starmer as Labour leader.

Luke Tryl, the More in Common pollster, says on Bluesky he can understand why Rachel Reeves thought twice before breaking Labour’s manifesto promise on tax.

Too much analysis was still treating breaking the tax pledge as “just another unpopular decision” rather than recognising consequence of breaking a promise which defined an election for the public. If is correct the govt won’t now break it they may have avoided a deeply scarring loss of public trust

This is not about tax (I remain convinced Labour could have pledged to reverse hunts NI rises and still won comfortably). But breaking a pledge which was so central to labours offer at a time when trust already fragile, and the public won’t buy circs have changed (this isn’t like the pandemic).

While Alex Wickham from Bloomberg reports that a better-than-expected fiscal forecast has allowed Rachel Reeves to drop the plan to raise income tax in the budget (see 9.03am), other explanations are also being offered. This is from an analysis from Beth Rigby, Sky News’s political editor.

I understand Downing Street has backed down amid fears about the backlash from disgruntled MPs and voters.

This is from Helen Miller, director of the Institute for Fiscal Studies thinktank, on the market reaction to the chancellor’s reported budget U-turn.

Investors will have 2 broad concerns about news that Chancellor won’t increase income tax rates

1. Does it signal less willingness to do politically difficult things

2. Will alternative tax increase be more damaging to growth

Yes to either will push up on govt borrowing costs

UK government borrowing costs still up after budget U-turn report, but initial spike has eased

Speculation the chancellor has scrapped plans to raise income tax sparked a sell-off in UK government bonds amid fears over unfunded spending pledges, PA Media reports. PA says:

Britain’s long-term borrowing costs were sent soaring as reports suggested the latest U-turn would leave Rachel Reeves scrambling to fill a gaping black hole in the nation’s finances just two weeks before the 26 November budget.

Yields on 30-year UK government bonds, also known as gilts, jumped as much as 14 basis points in early trading, and the yield on 10-year gilts also shot up 12 basis points – rising the most since July.

The yield moves counter to the price of bonds, meaning that prices fall when yields rise.

Yields later eased back a little, with 30-year gilt yields standing seven basis points higher at 5.3% and 10-year gilt yields up six basis points at 4.5%.

Sterling initially fell on the political concerns swirling around the budget, falling 0.3% against the US dollar and euro, before later regaining its poise to remain largely flat at 1.32 US dollars and 1.13 euros.

Kalyeena Makortoff has more on this on our business live blog.

These are from Ben Zaranko, an economist at the Institute for Fiscal Studies, on the chancellor’s U-turn, and in particular on the FT’s claim that, instead of putting up income tax, she will “rely heavily on what has been dubbed the ‘smorgasbord’ approach of increasing a range of narrowly-drawn taxes”.

Considerable risks with this approach: 1) revenues more uncertain; 2) greater risk of damaging economic impacts; 3) lots of angry interest groups, makes U-turns more likely; 4) viewed less favourably by bond market investors, many of whom were expecting an income tax rise.

But on the flip side, it could allow a Budget that doesn’t strictly break manifesto promises (which isn’t a trivial concern given low trust in politicians). It is possible to raise tens of billions without raising rates of the big 3 taxes. It’s just really, really difficult.

Here’s an extraordinarily cynical take: did the government talk up the likelihood of a manifesto-breaking income tax rise in the knowledge that it would push down gilt yields in the window the OBR will use for its forecasts?

This is from Kevin Schofield from HuffPost UK this morning.

Senior Labour source: “Keir and Rachel – in office, but not power.”

This morning a Treasury spokesperson issued this statement in response to the reports that Rachel Reeves has abandoned plans to raise income tax in the budget.

We do not comment on speculation around changes to tax outside of fiscal events. The chancellor will deliver a budget that takes the fair choices to build strong foundations to secure Britain’s future.

Alex Wickham from Bloomberg is reporting that Rachel Reeves dropped her plan to raise income tax in the budget after the fiscal forecast improved. He says:

Rachel Reeves received an improved fiscal forecast from her budget watchdog putting the fiscal hole at £20 billion, leading her to drop plans to raise income tax rates, people familiar with the matter said.

The latest update from the Office for Budget Responsibility moved in a significantly better direction due to the strength of receipts and stronger wage performance.

As well as filling the £20 billion gap, Reeves is still expected to deliver headroom against her fiscal rules of between £15 billion and £20 billion.

An expected productivity downgrade from the OBR has been partially countered, the people said.

Wickham also says, on the basis of what he has been briefed, that Reeves “will likely lower income tax thresholds at the budget [see 8.57am] and raise significant taxes from salary sacrifice schemes”.

The Treasury has now triggered speculation that, to compensate for not rising the basic rate of income tax, it will have to bring down the threshold at which people start paying higher rates.

In its story the Financial Times says:

The chancellor is now exploring alternative ways to fill a fiscal hole estimated by economists to be up to £30bn.

One option to raise revenue would involve cutting the thresholds at which people pay different rates of income tax, while leaving the headline basic and higher rates of the tax unchanged.

Reeves was pictured leaving Downing Street earlier this month with her diary on display, with a single word written in relation to a meeting: “Thresholds.”

Rachel Reeves and Keir Starmer were nervous about putting up the main rate of income tax because that would have been a direct breach of the Labour manifesto, which said:

Labour will not increase taxes on working people, which is why we will not increase national insurance, the basic, higher, or additional rates of income tax, or VAT.

But Labour has already increased employer national insurance, which was seen by many as a breach of this pledge. Reeves is expected to extend the freeze in income tax thresholds and this would increase the amount of income tax people pay, although technically it would not be a breach of the manifesto if the manifesto is understood as referring just to headline rates.

Bringing down thresholds would also be seen as a breach of the spirit of the manifesto, if not the letter of it.

SNP says Labour acting like it’s ‘completely lost control’ and Starmer on his way out

Stephen Flynn, the SNP leader at Westminster, says the latest news about the budget shows the government is in chaos. In a statement this morning, he said:

This isn’t government, this is chaos.

Labour give the impression of a party that has completely lost control – playing a dangerous game with people’s finances so that their prime minister can try to cling to power.

But everyone now knows the clock is ticking until he is dumped from Downing Street. His last act should not be to play fast and loose with the public finances – they’ve already more than paid the price for the constant chaos and crisis that passes for politics at Westminster.

Lib Dems welcome reported ‘screeching U-turn’ on income tax, and urge Reeves to tax banks more

This is from Daisy Cooper, the Liberal Democrat Treasury spokesperson and deputy leader, on the reported budget income tax U-turn.

If true, this 11th hour screeching u-turn might just spare struggling families from yet another punch in the stomach Budget.

The Chancellor should look at our plan for a windfall tax on the big banks’ billions in profits and put £270 back into people’s pockets.