Source: Sharecast
The chancellor had been widely expected to raise the rate for both higher and basic income tax payers at this month's Budget, despite manifesto pledges to the contrary
But according to the Financial Times, which first broke the apparent about-turn, the chancellor had “ripped up” proposals to raise both basic and higher income tax rates.
Citing unnamed officials briefed on the move, the newspaper said Number 11 was concerned any hike would anger voters and antagonise Labour MPs.
That unnerved investors, and gilts initially sold off steeply on Friday morning, with the 10-year yield up 13bps points at 4.57% at the start of trading.
The pound was also weaker against both the dollar and the euro.
However, subsequent reports said the decision had been taken because the government had received a better-than-expected fiscal forecast from the Office for Budget Responsibility.
Citing unnamed people familiar with the matter, both the FT and Bloomberg said an expected black hole of up to £35bn was now closer to £20bn.
If confirmed, that would give Reeves more fiscal headroom and reduce the need for across-the-board tax hikes.
The update calmed bond markets, and by 1130 GMT yields were coming back down to 4.50%.
The Treasury said: "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."
Neil Wilson, UK investor strategist at Saxo Markets, said: "Markets are now trading on the political as well as the fiscal. But the chancellor is riding a tiger - by trying to do anything and everything to please markets, Reeves is now at their mercy. Appeasement never works.
"The problem with not raising income tax is that it’s mechanically the best lever; otherwise faced with such a large black hole, you have to scratch around with a load of smaller things, pulling all kinds of levers…that will probably squeeze growth even more."
Oxford Economics said: “This episode demonstrates the importance of the Budget as a test of market confidence in the UK government’s fiscal approach.
“If the government has done a volte-face, it would be a risky strategy. If the cause is political, with the government concerned about how voters will react, it may strengthen perceptions that the government lacks the appetite to take tough fiscal decisions.
“If it reflect favourable OBR forecast revisions, there’s a risk markets will question the credibility of those projections.”
Reeves is battling surging government spending and mounting debt alongside sluggish economic growth.
On Thursday, figures from the Office for national Statistics showed the economy unexpectedly shrank in September, after GDP contracted by 0.1%.
Inflation, meanwhile, although off highs, is still well above the Bank of England’s long-term 2% target, at 3.8%, while interest rates remain high by historic standards, at 4%.
