UK borrowing costs jump, stocks slide as speculation mounts over high-stakes budget

British government bond yields rose sharply on Friday following reports Finance Minister Rachel Reeves is no longer planning to raise income tax rates in the Autumn Budget later this month.

The yield on the benchmark 10-year gilt initially rose around 13 basis points in early trade, but was last around 7 basis points higher at 4.51%. Yields on the long term 20- and 30-year gilts were last seen 8.5 and 9 basis points higher, respectively. Yields and prices move inversely to one another.

The moves came as investors reacted to a report from the Financial Times of an income tax U-turn. The Treasury was not immediately available to comment when contacted by CNBC on Friday morning.

U.K. stocks were also lower. The FTSE 100 index shed over 1% in morning trade, with Lloyds, Natwest, and Barclays banks occupying the bottom of the index, each losing more than 2.7%.

Reeves had spent the past week apparently laying the groundwork for a manifesto-breaking rise in income tax, which split Labour party lawmakers and led to further turmoil in the already embattled party, whose leader Prime Minister Keir Starmer has dismal approval ratings. 

A proposed 2p national income increase was to be offset by a 2p reduction in national insurance, designed to hit passive income streams rather than working people. There are now expectations, however, that the £30 billion ($39.5 billion) hole in the government’s budget will be filled by a patchwork of smaller rises.  

It could be a “fiscal reckoning” as a patchwork approach will put pressure on the gilt market, Wren Sterling’s investment chief Rory McPherson told CNBC’s “Squawk Box Europe” on Friday.  

“Within the U.K., if we have more of the smaller taxes being targeted as part of the programme from Rachel Reeves, I think that’s going to put more pressure on the government, more pressure on them to go back to the bond markets and ask for more money, which in turn puts more pressure up on yields,” McPherson said.

He added that there has been a “big march down” in yields but now “we’re pulling away that that.” 

Volatility this year has left long-term borrowing costs hovering at their highest level since the late 1990s, with U.K. debt having the heftiest price tag in the G7. 

For Toni Meadows, head of investment at BRI Wealth Management, the government has found itself “between a rock and a hard place with regard to this budget.”

“They inherited a bad fiscal position but then made the situation worse with public sector pay awards. The reason that there has been so much speculation regarding this budget, more than any statement in recent history, is because everything they need to do is going to be unpopular. How can this statement simultaneously promote growth whilst having to cut spending and increase the tax burden to keep bond investors happy?” he said, noting that outstanding debt and service costs add pressure.

While the market is pessimistic, “the uncertainty of not knowing the exact detail is more damaging in the short term,” Meadows said, adding that detailed plans are required for investors to be able to move beyond speculation.

Julian Howard, chief multi-asset investment strategist at GAM Investments, suggested that “onerous restrictions” on pensions savings, ISAs, an expatriation exit charge, and capital gains and council tax changes could be on the cards.

“The Chancellor will doubtless inflict enough misery later this month to fix the immediate problem but the emerging challenge the markets are hinting at may now be one of more general economic credibility,” he said.

Wren Sterling’s McPherson added that the Bank of England will still be able to make an interest rate cut after the budget, if it wants to. Other investors appear to have curbed their optimism, with bets on cuts shedding six basis points compared with Thursday, according to data compiled by LSEG.

The Autumn Budget is expected on Nov. 26.

— CNBC’s Chloe Taylor and Sam Meredith contributed to this report.