LONDON — Concerns regarding the recent U.K. budget that proposes tax increases seemed to diminish on Friday as the interest rates on British government debt stabilized, and the pound appreciated against a majority of other currencies.
Following the budget statement delivered on Wednesday, which marked the first by a Labour government in 14 years, British financial markets experienced volatility. Investors adopted a cautious stance, leading to a sell-off of both government bonds and the pound.
The budget outlined tax hikes amounting to £40 billion ($52 billion), representing the most significant increase in over 30 years, alongside an uptick in borrowing and spending. This combination evidently rattled some investors. Concerns surfaced among analysts regarding the inflationary effects of the budget, suggesting it might compel the Bank of England to proceed with interest rate cuts more cautiously than previously thought. Although the central bank is largely expected to decrease its main interest rate to 4.75% next week by a further quarter-point, market predictions now indicate fewer cuts for the upcoming year as a fallout from the budget’s announcement.
Additional commentary from analysts indicated that the nation’s finances may require further reinforcement in the coming years if the U.K. does not see an improvement in economic growth. The Office for Budget Responsibility, an independent fiscal watchdog, indicated in its budget appraisal that the proposed measures would likely have a limited impact on enhancing growth in the years ahead.
On Friday, the yield on the U.K.’s 10-year bonds remained stable at 4.45%, following earlier increases caused by Treasury chief Rachel Reeves’ budget presentation. The pound also appreciated by 0.4%, reaching $1.2951.
Prior to delivering the statement, Reeves was evidently aware of the potential repercussions a budget can have on financial stability. Two years prior, the brief tenure of Prime Minister Liz Truss collapsed due to a series of unfunded tax reductions that caused a surge in borrowing costs.
“While the market’s negative reaction is less than ideal for the new Labour government, it has been considerably subdued compared to the response to the Conservative’s mini-budget from September 2022,” stated Andrew Goodwin, chief U.K. economist at Oxford Economics.
The overall tax increase proposed by Reeves primarily stems from a hike in the national insurance contributions businesses are required to pay for their employees. The rise by 1.2 percentage points in employer contributions, along with its application to lower income levels, is anticipated to generate an additional £25 billion.
Several business executives have voiced apprehensions regarding this move, contending that it could lead to wage stagnation as companies look for ways to mitigate the extra expenses.
The Labour Party, which is center-left, achieved a significant electoral victory on July 4, pledging to bring an end to years of upheaval and controversy under successive Conservative governments while committing to rejuvenate the U.K. economy and restore public services. Nevertheless, the breadth of the measures revealed by Reeves on Wednesday exceeded the Labour Party’s cautious stance during the general election campaign.