The forthcoming budget, to be delivered by Chancellor Rachel Reeves on November 26, is under intense scrutiny from City investors, who warn that disappointing fiscal plans could lead to significant market instability and even necessitate a second budget. David Zahn, head of European fixed income at Franklin Templeton, highlighted the primary risk as bond yields rising sharply, potentially reaching an "unsustainable" 6% for 10-year or 30-year UK bonds, a scenario he likened to a "death spiral." Such a reaction from the bond market would compel the government to revise its fiscal strategy.

Zahn expressed skepticism about the budget's reception, particularly after plans for a manifesto-busting income tax increase were abandoned. He argued that without substantial spending cuts or "real tax increases," investors are unlikely to push down borrowing costs by purchasing more gilts. He suggested that markets would ideally prefer Reeves to create fiscal headroom "north of £20bn" to assure adherence to fiscal rules, especially given the current limited headroom, which is estimated to be around £10bn and potentially eroded by downgrades in productivity growth forecasts. This leaves the Treasury highly susceptible to market fluctuations and economic shifts.

In response to the need for revenue, Reeves is reportedly considering a "smorgasbord" of increases, including keeping the freeze on tax thresholds in place for another two years. This policy alone is estimated to generate over £8 billion annually for the Treasury by drawing more workers into higher tax brackets as wages rise. However, this comes at a significant cost to Britons, with predictions that over 10 million people could face top-rate tax by the end of the decade, and even full-time minimum wage workers seeing an annual tax bill increase of £137. Furthermore, by 2027-28, all pensioners are expected to face tax on the full state pension, effectively negating some state benefits.

Adding to the revenue-raising efforts, the Chancellor is also reportedly exploring a "brutal raid" on bank profits. Fears of an increased "banking surcharge" – a higher rate of corporation tax for banks – led to a sell-off in bank stocks, with Barclays, Lloyds, and HSBC shares dropping over 2% recently. While the Treasury had initially downplayed this prospect, reports suggest the surcharge is back on the table as Reeves seeks to raise as much as £40 billion to stabilize the nation's finances.

The political landscape further complicates matters. James Smith, an economist at ING, noted that any post-budget bond yield spike could stem from political factors, particularly if Prime Minister Keir Starmer faces mounting pressure or a leadership challenge. A new, potentially more left-leaning chancellor could be perceived by markets as more likely to alter fiscal rules and increase borrowing, exacerbating investor concerns. The lingering impact of the Liz Truss mini-budget crisis of 2022 continues to cast a shadow, with Michael Browne of Franklin Templeton Institute emphasizing that markets remember and remain cautious about the UK's economic direction, seeking clear evidence of more than just "muddling through." Zahn also predicted a recurrence of tax rises next year, indicating that the current fiscal challenges are not a one-off event.