The UK Chancellor looks to have stepped back from direct income tax increases, but her indecisiveness has unnerved investors
Latest insights:
After spending the last few weeks preparing the public and markets for budget income tax hikes, Chancellor Rachel Reeves performed a screeching U-turn last week and ruled them out. It has been suggested that new forecasts from the Office for Budget Responsibility (OBR) around wages and tax receipts knocked several billion pounds off the fiscal gap the Chancellor is seeking to close, giving her more room to manoeuvre. A more cynical interpretation might be that the Labour government lost its nerve over a policy that would have broken a pre-election promise.
Either way, the markets, which had been reassured by the Chancellor’s hardheaded approach to public finances, reacted negatively to the news. The cost of government borrowing immediately spiked, while the pound dipped against the dollar and the euro. The pound has now lost 1.5% of value to the euro in the last month.
What now for the budget?
With income tax rises off the table, how will the Chancellor pull off the tricky balancing act of closing the UK’s fiscal gap without undermining growth or hitting already hard-pressed public services like the NHS? According to reports, Reeves aims to raise £7.5bn by freezing tax thresholds, which will raise tax receipts through inflation and wage growth.
But the threshold freeze, along with other measures, will raise far less revenue than might have been expected from a direct income tax hike, making it more likely that the Budget will be badly received by investors. If that’s the case, exchange rate fluctuations can be expected.
Coming up:
While the Autumn budget continues to dominate sentiment in the UK, US investors have been cheered by the reopening of federal government services after the longest shutdown in history. Markets will now focus on earnings from several major companies next week and, in particular, chipmaker Nvidia. Nvidia is a key player in the AI boom, which some commentators have described as a bubble waiting to burst. Its earnings will be closely watched.
European investors can expect flash manufacturing and services PMIs (measures of business confidence based on manager surveys) from Germany, France and the wider EU (Friday), and inflation data from the UK (Wednesday).
