Why Britain’s Budget Bluster Shouldn’t Tax Markets

Editors’ Note: MarketMinder is politically agnostic. We prefer no party nor any politician and assess developments for their potential economic and market implications only.

Three weeks from tomorrow, while our American readers will be trussing turkeys and baking pies, our UK readers will be digesting something less flavorful: Chancellor of the Exchequer Rachel Reeves’s Budget, which she seemingly conceded will include broad tax hikes. There is abundant speculation about what this will entail. And its economic and market impact. So here is a friendly, hopefully encouraging reminder: Whatever Reeves announces, it is unlikely to sway markets for long.

To be clear, we don’t know what Reeves will announce. No one does—maybe not even her. But the government has hinted it will break her Labour Party’s manifesto pledge not to raise taxes on “working people,” which boils down to income tax, value-added tax (VAT) and employees’ National Insurance Contributions (NIC).

Last week, when asked whether he would rule out breaking that manifesto pledge, Prime Minister Keir Starmer gave a non-answer. The swift public backlash theoretically gave his public relations folks an opportunity to do some cleanup and reiterate those commitments, but there wasn’t much of a damage-control effort. Fast forward to Tuesday, when Reeves’s Budget preview speech alluded to tax hikes. It was indirect. Most of the speech touted her investment and growth plans. But then she warned about the deficit and the need to maintain credibility with markets, admitting “additional investment can only be delivered because markets know that my commitment to the fiscal rules is ironclad.”^[i] She later noted, “We were elected on a commitment to put country before party; the national interest before political calculation.”

Take those words as you may, but most interpreted this all as confessing tax hikes are coming, in breach of earlier promises, to fund higher public investment. Headlines across the political spectrum cried foul. Polls show tax hikes are overwhelmingly unpopular, and the backlash was bipartisan.

But a political backlash doesn’t dictate a stock market backlash. The two often don’t go hand in hand. Heck, it is only one day, but MSCI’s broadest UK stock market index rose slightly in pounds yesterday. So did the FTSE All Share Index.

At such times, it is helpful to remember how stock markets work. They are efficient, discounting all widely known information. Maybe that sounds a little academic, so let us break it down. It means, essentially, that whenever someone makes a trade, their decision to buy or sell incorporates all information at their disposal. All the forecasts and headlines; all their observations, hopes, fears, opinions and expectations. Multiply that across the millions who buy and sell daily, and you get a market whose prices incorporate popular expectations.

So the question for investors now isn’t whether tax hikes are good or bad. Nor how large their economic effects will be. Nor whether Reeves might raise more revenue by simplifying the tax code and letting economic growth lift the Treasury’s take, as a report making the rounds Wednesday argued. These are important policy questions. But for markets, it simply matters whether tax hikes will have any negative surprise power left.

We doubt it. Last year, when Reeves attempted to raise revenue without breaking manifesto commitments, most forecasters expected it wouldn’t suffice. They presumed market volatility would wipe out the fiscal cushion she had penciled in. Then, as the Bank of England and nonpartisan Office for Budget Responsibility (OBR) revised their economic forecasts lower—indirectly lowering expected tax revenues—speculation escalated. It resurged when Reeves’s and Starmer’s welfare reforms got watered down. And earlier this fall, when rumblings that the OBR would lower its productivity estimate began. Since OBR forecasts drive fiscal policy, this put the onus on Reeves to find more revenue.

By the time Reeves spoke yesterday, expectations that she would raise income tax, VAT or employee NIC were baked into the pie. Headlines have warned of this outcome for months. It is impossible for something to be so widely known to society but unknown to stocks. Traders and investors aren’t locked in bunkers with no link to the outside world. They see the same headlines you do.

Plus, we are still three weeks from the announcement. Experience tells us these three weeks will be full of lobbying, policy leaks, fearful forecasts—your typical pre-Budget circus. The noise will give markets the opportunity to continue pre-pricing potential changes and their effects. To the extent any surprise power exists now, it will probably be even smaller on Budget day.

It is also important not to overestimate taxes’ effect. No one likes paying higher taxes. They pinch household budgets immediately, while any potential fruit from public investment is further off and risks being muted by inefficiencies. Yet taxes are only one variable affecting economic growth, and the economy is only one driver affecting markets. There is a long history of tax hikes and cuts in the UK, just like the US. It shows tax cuts aren’t reliably bullish and hikes aren’t automatically bearish.

We have a theory on why this is: Markets prefer falling uncertainty. Tax hike chatter raises uncertainty. We have seen this all year in the UK, with everyone expecting taxes to rise but lacking specifics. Finally knowing which rates will rise and by how much gives people the clarity they need to move on. Stocks like clarity and relief. And if a bigger tax hike now ends the annual Budget nerves, that might keep uncertainty low from here. It is just a possibility, but one we don’t see many folks talking about—the kind of stealthy bullish force that powers stocks up the wall of worry.

So whatever Reeves announces, however important it seems personally or societally, remember stocks aren’t personal or sociological. They move most on the gap between reality and expectations over the foreseeable future. Tax hikes aren’t a surprise, and they set expectations lower. Seems stealthily bullish to us.