Large tax hikes loom as bond market rout squeezes UK budget

Sharp falls in global bond markets have pushed the 10-year gilt yield to its highest level since August 2007, eroding the fiscal headroom the Treasury had counted on. Economists say the move makes a set of "large tax hikes" almost inevitable at the Budget slated for 28 October.

Bond market turbulence shrinks fiscal space

According to Handelsbanken's senior UK economist, the jump in gilt yields could wipe out the £22.7 billion cushion that Chancellor John Healey had previously identified. The bank warned that the higher cost of borrowing would "add to the likelihood that fresh tax increases will be announced on 28 October".

Research from Pantheon Macroeconomics echoes the sentiment. Analysts Rob Wood and Elliott Jordan-Doak calculate that the fiscal headroom has fallen to roughly £13 billion, well below earlier forecasts of around £15 billion before the bond sell‑off.

Fiscal pressures force tax options

The Office for Budget Responsibility will have to revise upward its estimates of debt‑interest payments. It now expects the government to spend about £135 billion on debt service over the next five years, with roughly £110 billion due this year, almost double the amount allocated to defence.

Healey faces a £1.2 billion annual shortfall in the defence investment plan, alongside a pledge to strip VAT from energy bills, a measure that could cost the Treasury around £800 million a year. The government is also under pressure to lift defence spending to 3 percent of GDP, a rise of roughly £10 billion.

Outlook for the October budget

Political context adds urgency. Healey stepped down as defence secretary under Sir Keir Starmer's administration after failing to secure a commitment to the 3‑percent defence target by 2030. Lord Jim O’Neill, former Goldman Sachs executive who advised Andy Burnham, warned that a capital‑gains tax hike is likely, though he cautioned it could dampen risk‑taking.

"It will force even more genuine risk takers to be discouraged and think about either moving or not doing as much of this kind of thing as they've done," said O’Neill in an interview with LBC.

Analysts expect the chancellor to announce a package of tax measures, potentially higher income tax rates, a revival of capital‑gains tax, and possibly a reinstatement of the energy‑VAT cut, to bridge the widening gap. The moves will raise the cost of borrowing for businesses and households, while also reshaping the political debate ahead of the next general election.

For a deeper look at how soaring gilt yields are adding to the debt bill, see the recent report on UK gilt yields hitting an 18‑year high.