Prolonged uncertainty around fiscal policy is causing decision paralysis at UK business, consultancy firm AlixPartners has warned:

Taxation has become the UK’s own tariff, undermining business with the same unpredictability as any trade barrier.

But headlines fixating on tax rates miss the deeper issue.

The real damage for companies comes from prolonged uncertainty and speculation that paralyse strategic planning and investment decisions.

CEOs are pushed into behaving like currency speculators, making high stakes calls on shifting ground. And recent history shows that each budget provides fleeting clarity before the cycle begins again.

Investors are reportedly piling bets against the pound, amid concerns over how Reeves will fill the fiscal black hole by the time the budget comes around on 26 November.

Citing analysts from Bank of America, Reuters is reporting that traders are amassing short positions on the UK currency, which is now the second worst performing major G10 currency over the past three months, having dropped 3% against the US dollar to about $1.315.

Our political editor Pippa Crear has confirmed that sources are now ruling out cutting the thresholds for paying higher rates of income tax, and that we should expect “income tax thresholds to be frozen for another two years, taxes on salary sacrifice schemes, fuel duty equivalent for electric vehicles - plus ‘smorgasbord’ of other measures.”

More on that over at our politics live blog:

The left-leaning New Economics Foundation is warning that – regardless of whether there is an improved OBR forecast signalling a smaller fiscal black hole – the government has to be “bold” to support the country after years of austerity and meet the challenges of an aging population.

While the NEF said it was clear that some tax hikes were inevitable, it warned against cutting income tax thresholds, saying the move would drag people who were already struggling with low wages, into paying taxes they can’t afford.

That could spell trouble for families without further efforts to ease cost of living pressures.

Hannah Peaker, the NEF’s deputy chief executive, said:

Any tax rise should be progressive by starting with the wealthiest, not push up inflation and be earmarked for voter priorities like the NHS and the cost of living.

Equalising capital gains so profits from investment are taxed at the same rate as wages would be an important first step.

But the government must also use this budget to signal how it will boost long-term investment and productivity.

Reassessing its fiscal framework and the OBR’s role in examining it has to be a priority, as well as closer working with the Bank of England.

US stock futures are pointing to lower market open state-side, extending Thursday’s sell-off which was sparked in part by doubts over a Fed interest rate cut in December.

Global stock markets are also being hit by jitters that AI stocks have been overvalued, and are due a price correction.

• Dow futures are down 0.58%

• S&P 500 futures are down 0.9%

• Nasdaq futures are down 1.38%

Richard Hunter, head of markets at interactive investor, says:

Investors have been shuffling uncomfortably in their seats with AI spending going into overdrive, the success of which will not become apparent for some time, and the stretched valuations which have resulted from the relentless buying interest.

The Nasdaq bore the brunt of the latest uncertainty, led by declines in the likes of Nvidia, Alphabet and most recent market darling Palantir Technologies. In addition, there was also a reminder that sentiment is skittish as Disney shares fell by almost 8% following a mixed set of fourth quarter numbers.

At the same time, Hunter says, there are concerns that – despite the US government shutdown having ended – the lack of economic data caused by the shutdown (which has eft the Federal Reserve “dealing blind”) may not be delivered in time for the Fed’s next meeting in December.

Hunter adds:

As such, investors considered that the Fed may therefore decide to play safe and stay put on interest rates until full visibility is restored.

Comments from several Fed members that monetary policy should remain restrictive led to a dip in the market consensus for a cut, dropping to a 50/50 chance from what had been all but nailed on just two weeks ago.

10-year and 20-year gilt yields are on the rise again, as investors try to determine how confident they are about the Labour government’s ability to raise enough funds to offer some fiscal certainty and stability long-term.

The 20-year gilt yield is at 5.233%, up 0.125 percentage points.

That is the highest level since mid-October.

Estimates by Berenberg suggest that the UK government needs to raise £30bn, or around 1% of GDP, in the 26 November budget into order to get back on course to meet its fiscal target to meet all day-to-day spending with tax revenues by 2029-2030.

Berenberg explains that each percentage point increase in income tax rates would raise over £10.5bn by the time that target year rolls around.

However, a 2 percentage point increase would be a “simple, relatively efficient and front-loaded mechanism with which to raise over £20bn,” Andrew Wishart, senior UK economist at Berenberg says.

But in order to avoid breaking Labour’s manifesto pledge to not “increase national insurance, the basic, higher, or additional rates of income tax, or VAT”, the government is said to be instead looking to lower the threshold at which income tax increases from 20% to 40%.

But simply reducing the threshold from £50,270 per year to £46,000 would still leave the public finances £6bn short of what it could raise through an income tax hike by 2029-30, “thereby making additional hikes in smaller taxes necessary, too,” Berenberg says.

Wishart explains:

As a result, the likelihood that the government will have to raise taxes again (or cut spending) in the future, in turn generating further bouts of policy uncertainty, has grown.

He adds:

A smaller and more back-loaded fiscal tightening would therefore damage the government’s fiscal credibility and limit the extent to which the Bank of England lowers interest rates in 2026.

That is the straightforward economic explanation for the 7bp rise in the 10-year gilt yield to 4.50% today.

The u-turn also demonstrates a lack of political competence which has probably led investors to increase the probability they attach to a change in the leadership of the Labour party and government.

The risk is that the Labour party replaces Keir Starmer and Rachel Reeves with a duo positioned further to the left on the economic policy spectrum and less committed to fiscal sustainability.

UK stock indexes are still suffering, with the FTSE 100 losing further ground and trading down 1.3%.

There are only three companies trading in positive territory, with banks like Lloyds and NatWest still among the biggest fallers, each down around 3.3%.

Analysts are expecting further easing in bond prices as investors digest the flurry of news on Reeves’ budget plans.

Hal Cook, senior investment analyst at Hargreaves Lansdown says:

As is often the case with quick reaction to surprising news, it’s likely that these moves are over-reactions and yields definitely have potential to come back down from here.

Just because Labour may no longer be planning on increasing income tax, we don’t yet know what they may plan to do instead.

Government bond markets definitely have the power to keep government budgets in check, as we saw in the UK with the Truss mini-Budget in 2022 and in the US around Liberation Day earlier this year. Watch this space.

Full story: UK borrowing costs up after markets spooked by Reeves’s income tax U-turn

Borrowing costs for the UK have increased and the pound fallen after the chancellor’s extraordinary last-minute decision to ditch tax-raising plans in the upcoming budget.

Interest rates on government bonds rose by more than 10 basis points in early trading, putting them on track for their worst day since 2 July, when investors responded to a tearful appearance by Rachel Reeves in the House of Commons chamber. The pound meanwhile dropped 0.5% against the dollar.

The market reaction came after government sources confirmed Reeves had dropped plans to raise income taxes to help close a budget shortfall of about £30bn.

The U-turn came despite weeks of warnings to Labour MPs and the wider public that the chancellor might have to break her manifesto pledges on tax to avoid a market meltdown.

Reeves has been working on plans for weeks to raise income taxes at the budget, despite having promised not to do so before the election.

The chancellor has even invited external experts to brief Labour backbenchers on the difficult decisions they are likely to have to defend.

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The pound is now trading down just 0.24% versus the dollar at around £1.3159.

The 10-year gilt yield is now up 0.06 percentage points at 4.49%

Across long-dated government bonds, the 20-year gilt yield is now up just 0.085 percentage points at 5.193% while the 30-year gilt yield is up 0.091 percentage points at 5.324%.

The chancellor’s income tax rate hike reversal may be interpreted as the Labour government prioritising their public popularity ratings, and stability of the political party, above the need to stabilise the UK’s finances, analysts have warned.

Lee Hardman, senior currency economist at MUFG, says:

The initial negative reaction for the pound today … is an indication that the government’s fiscal tightening plans are viewed as less credible by market participants without an income tax hike.

The decision to drop the income tax hike could be viewed as the Labour leadership prioritising their popularity with the public and the stability of the Labour party over doing what is best to restore confidence in the public finances.

Nevertheless, we still expect the package of fiscal tightening measures to put a dampener on economic growth in the UK and create more room for the BoE to lower rates further.

The releases this week of the weaker UK labour market and GDP reports have reinforced negative sentiment towards the pound in the near-term.

This has all left investors '“scratching their heads” and expecting a “death by a thousand cuts” kind of budget, if Reeves hopes to find money to fund key policies including ramped up UK defence commitments, according to XTB’s research director Kathleen Brooks:

The u-turn on income tax rises, while better for growth in a service-based economy, does leave markets scratching their heads about how to fund scrapping the two child benefit cap, the ballooning benefits bill and Britain’s defense commitments.

Instead, the budget is likely to be death by a thousand cuts, in the form of hundreds of tax rises announced on the 26^th, which one source called a smorgasbord of fiscal choices for the chancellor.

Kathleen Brooks, research director at XTB notes that Reeves’ change of plans is essentially leaving policy pledges unfunded, with the chancellor now faced with finding an alternative way to raise money to fill an estimated £30bn fiscal hole in (checks watch) less than 2-weeks.

Brooks says:

This also means that the chancellor has signalled billions of unfunded spending pledges, which the bond market is not fond of.

Hence why yields are rising sharply across the curve. The 10-year yield is higher by 10bps, while the 2-year yield is higher by 9bps at the open. 30-year yields are taking an even bigger hit and are higher by 12bps.

Bond market volatility is not what the chancellor wants to see with less than two weeks to go before the budget.

Essentially, the bond market is warning the chancellor that she cannot merely tax the ‘rich’ to fund her lavish spending pledges. Either she broadens the tax base, or she cuts spending.

Culture secretary Lisa Nandy has weighed in on the chancellor’s plans to drop awhat would have been a manifesto-breaking income tax hike this morning.

Nandy told Sky News that Rachel Reeves remains “completely focused” on the public interest, but added it would not be “helpful or right” to speculate about what is in the November 26 budget.

When asked if the latest reported u-turn made it look like the Labour government' didn’t know what it was doing, Nandy said:

I’ve known the Chancellor well for 15 years now, and I can tell you that she is solely and fiercely focused on the challenges facing the country and doing what is in the best interests of the country.

She’s never been shy of facing people down in order to do that in opposition and in government.

Over the course of the last few weeks, obviously I’ve had some discussions with her and her team about measures in the budget that may affect my department, proposals that we’re making, and discussions that ordinarily happen across government, and in every one of those discussions, it’s been the public interest that she’s completely focused on.