On Friday, UK government bonds experienced a sharp decline as investors reacted to a surprising policy reversal by Sir Keir Starmer and Rachel Reeves. The two leaders scrapped plans to increase income tax rates in the upcoming Budget, a move initially intended to address a potential £30 billion shortfall in public finances.

The Financial Times revealed on Thursday night that the prime minister and chancellor decided against breaking their manifesto promise to maintain the current basic and higher income tax rates. This decision was influenced by concerns over possible voter backlash and opposition from some Labour Members of Parliament.

The immediate reaction in the gilt market saw a significant sell-off, causing the 10-year bond yield to rise by 0.1 percentage points to 4.54% during early trading. It’s important to note that bond yields and prices move inversely.

Later in the day, UK bonds regained some stability, with the 10-year yield settling at 4.49%, a 0.06 percentage point increase, as traders found reassurance in statements from the Treasury about Reeves’ plans to maintain fiscal flexibility.

Meanwhile, the pound fell by 0.5% against the dollar, valued at $1.312, and reached a new two-year low against the euro.

Rather than increasing income tax rates, the chancellor is considering lowering the income thresholds that determine tax rates. Reeves was already anticipated to continue an existing freeze on personal tax thresholds.

People familiar with the matter said Reeves would also rely heavily on what has been dubbed the “smorgasbord” approach of increasing a range of narrowly drawn taxes.

The U-turn comes days after a leadership crisis threatened to engulf Starmer’s premiership and forced health secretary Wes Streeting to deny he was challenging the prime minister.

However, Downing Street officials insisted the Budget had not been rewritten in response to the briefing debacle.