Reeves Faces Market Angst As Budget Relies On Small Tax Hikes

The Chancellor Rachel Reeves has found herself with limited choices in crafting the next Budget, resorting to an array of minor tax increases as plans to raise income tax rates were abandoned. Market scrutiny has intensified, with investors wary of the adverse effects that a patchwork of incremental tax changes may bring, reminiscent of previous budgets that ended in confusion. This approach, aimed at avoiding a breach of manifesto pledges, risks greater fallout if perceived as lacking fiscal coherence.

Recent history lingers in the minds of investors, particularly the consequences of the 2012 Budget, when market confidence in Britain’s economic management was higher than today. UK ten-year borrowing costs now surpass those of all other G7 nations, with the yield exceeding comparable US bonds and sitting more than a percentage point above those of Italy and France. When the income tax rise was scrapped, markets responded with a clear sell-off in government bonds, temporarily pushing yields higher and immediately raising the anticipated annual interest costs borne by the Treasury.

The Office for Budget Responsibility estimates that every one percentage point rise in interest rates adds £17 billion to annual debt servicing costs, a staggering burden that equates to half the Home Office budget. Against this backdrop, the market demands credible action to signal a firm commitment to managing the national debt, yet the Budget’s reliance on dispersed and potentially distortionary tax changes has not instilled much confidence.

Investors and economic analysts have noted that key revenue-raising measures will be slow to take effect. Instead of immediate boosts, some taxes will remain frozen until 2028 or beyond, while others, like property-related levies, are set for future implementation. This backloaded strategy delays difficult decisions and feeds scepticism about the strength of fiscal resolve. Many in the City believe that only swift, front-loaded increases would have delivered the reassurance required by investors, helping to keep borrowing costs in check.

The situation is exacerbated by internal political uncertainty. Many in the financial sector now question the Government’s capacity to execute difficult fiscal reforms, even with a large parliamentary majority. Concerns persist about the credibility of the policymaking process, especially after policy reversals on welfare and benefits. The prospect of further political instability, including possible leadership challenges within the Labour Party, only adds to market unease and leaves gilt yields at persistently elevated levels.

Among the Budget’s intended mitigations are measures such as a cut to energy bills and freezes on rail fares and prescription charges, all aimed at curbing inflationary pressures. Each move, however modest, contributes incrementally to controlling headline inflation, aiding efforts to steady government finances. Yet within the investment community, trust has been eroded and the damage to official credibility is seen as difficult to reverse.

The real test for Rachel Reeves and the Government will likely arrive after the Budget’s immediate aftermath. As investors monitor the political and market response, questions will remain over whether fiscal policy can truly steady the public finances, or if ongoing turmoil will keep borrowing costs high and investor confidence fragile.