The UK government is considering abandoning its tax increase plan; British bond yields have posted the largest rise since July, and the pound has slumped in response.

On November 14, according to media reports, UK Chancellor of the Exchequer Rachel Reeves abandoned the previously proposed plan to raise income tax. After the announcement, the market reacted sharply, with the UK stock market, bond market, and the pound exchange rate all dropping together.

Specifically, the yield on UK 10-year government bonds once surged by 13 basis points before retreating to 4.50%, still up 7 basis points for the day. The pound fell 0.2% against the US dollar to $1.3168; the FTSE 100 index fell by more than 1% in early trading.

The policy shift has once again sparked investor concerns about the UK's fiscal health. The market generally expects the government may rely on a series of small tax increases to fill the budget gap, which could further intensify pressure on the government bond market.

Complex background for policy shift, budget gap remains to be filled

Behind the policy shift are complex political and fiscal realities. According to media reports, Reeves had, a week earlier, paved the way for a tax increase proposal that would break Labour's campaign promises, triggering divisions within the party and exacerbating Labour's already troubled internal turmoil. Meanwhile, Prime Minister Keir Starmer's approval ratings continue to be sluggish.

The original proposed plan was to increase the national income tax rate by 2 pence, while lowering national insurance contributions by 2 pence. Currently, the public expects the government will rely on several small tax increases to fill a budget gap of up to £30 billion (about $39.5 billion).

Investors are concerned that such "patchwork" fiscal policies may increase pressure on the bond market. Rory McPherson, investment director at Wren Sterling, said on a program that the scattered mix of tax increases may amount to a "fiscal reckoning," forcing the government to return to the bond market for financing and thereby driving up yields.

He further pointed out that UK government bond yields had "fallen sharply" previously, but the current market is reversing this trend. So far this year, the UK's long-term borrowing costs have remained high, approaching their highest levels since the late 1990s, making it the G7 economy with the highest debt financing costs.

Furthermore, market expectations for interest rate cuts from the Bank of England have also cooled. Data from the London Stock Exchange Group (LSEG) shows that investor bets on rate cuts have decreased by 6 basis points compared to the previous day. The UK government is expected to announce its autumn budget on November 26, at which time its fiscal trajectory and the market's response will face a new round of tests.

Risk warning and disclaimerThe market involves risk and investment should be approached with caution. This article does not constitute personal investment advice, nor does it take into account individual users' specific investment objectives, financial situations, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Investing on this basis is at your own risk.