Chancellor Reeves’ U-turn on income taxes has revived concerns over fiscal credibility and left long-dated Gilts vulnerable to renewed volatility. Even if the Autumn Budget narrows the fiscal gap, doubts over policy consistency are likely to linger. In this note, Alex Rohner at J. Safra Sarasin Sustainable Asset Management examines the implications for Sterling rates and why intermediate maturities may still offer the most resilient positioning.
Chancellor Reeves’ sudden U-turn on plans for higher income taxes has raised more concerns about the government’s ability to put public finances on a stable footing. Resistance against further fiscal consolidation from within the Labour party is rising and poses an important challenge for long-term Gilts in particular. In her Autumn Budget, Chancellor Reeves will announce measures that plug the estimated fiscal gap, and even leave some additional fiscal headroom compared to today, but it will likely be a budget that leaves a lot of questions open.
Therefore, the long end of the Gilt market in particular will be prone to sharp bouts of volatility on any adverse news flow. Despite the political risks, we retain our constructive view on the Sterling rates market in local currency terms. Policy rate expectations are likely to move lower, hence short and intermediate yields have more room to fall. That said, we would continue to stick with intermediate maturities that present the best risk/return trade-off.
OBR forecasts suggest smaller UK fiscal shortfall
Media reports on November 14 2025 suggested that updated forecasts from the Office for Budget Responsibility (OBR) point to a smaller fiscal shortfall in UK public finances, closer to GBP 20bn instead of a 30 to 35bn gap that had been previously anticipated. Most of the improvement seems to stem from expected higher tax receipts and from downgrades in productivity being more backloaded. As a reminder, the funding gap in the budget had opened up as the OBR had revised down its estimates for UK productivity, and hence real economic growth over coming years, and because of several about faces on previously announced spending cuts or their delayed implementation.
Yet another U-turn by the government
Given a smaller potential shortfall, Chancellor Reeves apparently seized the opportunity to change her plans for more broad-based income tax increases that she had already telegraphed to the British public. Instead, she is now said to pursue a mix of different tax measures, such as freezing tax thresholds and raising specific taxes such as wealth and property taxes, among others. Clearly, there are internal concerns about the unity and political credibility within the Labour party if the election pledge not to raise income taxes were to be broken. But the problem with the current approach is that repeated policy reversals for fear of a political backlash risk an even greater loss of confidence with voters and with financial markets.
Reeves risks losing trust from Gilt investors
Gilt investors, in particular, are looking for consistency and clarity in government policies. The current erratic behaviour of the Chancellor represents neither. The fact that she seems to have used the first opportunity to bail out of reasonable though unpopular income tax hikes, based on OBR forecasts that are fraught with uncertainty, is neither consistent nor clear, and risks denting trust. And trust is important since the Chancellor needs the Gilt market to play along if she wants to put UK finances on a stable footing.
Almost half of the term premium is related to Gilt-specific risk factors
Long-term Gilt yields have already built up a sizeable risk premium over the past 12 to 18 months, which is to be expected in an environment where concerns about higher inflation are increasing. However, the Gilt-OAS spread, the differential of long-term Gilt yields to the corresponding swap rate, has also risen significantly and sits currently at around 90bp in the case of a 30-year maturity, contributing almost 50% to the overall term premium. This premium reflects Gilt-specific risk factors, in this case primarily concerns about UK debt sustainability and hence potentially more issuance of Gilt securities in the future. Consequently, a more credible and durable fix for concerns about UK debt sustainability could meaningfully lower Gilt-risk premia and yields.
Gilt market likely to remain volatile
For the moment at least, it seems that this opportunity has been wasted. In her November 26 budget, Chancellor Reeves will most probably announce measures that plug the estimated fiscal gap, and even leave some additional fiscal headroom compared to today. But it will likely not be a budget with enough consistency and clarity such that current term premia on longer dated Gilts can fall meaningfully. Doubts of whether the size of her fiscal buffers are large enough will persist and hence the long end of the Gilt curve in particular will likely be prone to bouts of strong volatility on any negative piece of news. We therefore suspect that the Sterling yield curve will steepen out more.
UK politics are a risk for the long end of the Gilt market
Domestic UK politics will therefore be a risk factor for long-term Sterling rates. The Labour Party’s poll ratings have fallen sharply in 2025, and Prime Minister Starmer’s government is facing growing political pressures against more fiscal tightening from within. It would only take the signatures of 80 Labour members of Parliament out of 400 to mount a leadership challenge, and if that were to become a real possibility, markets could price the risk of a more left-leaning new government that is more likely to try to change fiscal rules and to borrow more.
Constructive view for the Sterling market
Despite heightened political risk, we retain our constructive view for the Sterling rates market, in local currency terms. The current market-implied BoE policy rate trajectory and real yields are likely too high and leave UK monetary policy still in restrictive territory. Moderate growth and softer inflation should allow the Bank of England to cut rates further, probably a bit more than markets price. Consequently, we expect that short and intermediate yields have room to fall further. The steep yield curve and elevated yield levels should allow for attractive expected total returns.
Stick with intermediate maturities
We have recommended the intermediate part of the sterling curve (5-7 years) for a long time, and current events underscore the notion that long-dated maturities are still fraught with a lot of risk, at least for now. In our view, intermediate maturities present the best risk/return-trade-off: firstly, they reflect the maturity bucket that has the steepest curve profile; secondly, they have sufficient duration to reap rolldown returns and profit from potentially lower intermediate yields, and thirdly, they have enough carry to provide a substantial cushion against adverse rate moves.
