Government borrowing costs jump on reports Reeves to drop income tax rise

UK government borrowing costs have risen sharply in reaction to news that the chancellor has decided against increasing income tax rates in the upcoming Budget.

The interest rate on 10-year government bonds, known as the yield, jumped from 5.44% to 5.56% in early trading, indicating the cost to government if it chose to borrow over this length of time.

The spike in yields reflected concern in the financial markets about how the government would meet its spending and borrowing commitments without an income tax rise.

But yields eased slightly later following news that the financial hole facing the government was going to be less than experts have been predicting.

Gilt markets reacted strongly on Friday morning to a Financial Times report that the chancellor was dropping the tax plan, but the markets eased slightly following news of the improved OBR forecast.

Ruth Curtice, chief executive of the Resolution Foundation - the think tank which first proposed the idea of raising income tax by 2p and cutting National Insurance by the same amount - said the latest Budget rumours risked exacerbating market movements.

"It is normal for economic forecasts and policies to change in the run up to the Budget. It is not normal for so much of that to be laid bare in public," she said.

"The market moves this morning and in recent weeks suggest a serious look should be taken at the approach to market-sensitive forecast information."

Oxford Economics' chief UK economist Andrew Goodwin said the episode showed the Budget would be a test of the market's confidence in the government's approach to finances.

"Smaller tax rises to tackle an apparently smaller problem aren't a good idea if markets don't believe the OBR's forecast is credible," he said.

He noted the OBR's forecasts have "consistently been too optimistic about growth, and if those forecasts were not fixed it would be "risky" for the chancellor to pin all Budget plans on them.

"There's a good chance that markets would conclude the problems aren't resolved and the government will be back in the same situation at the next fiscal event."

A Treasury spokesperson 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."