Britain’s government is likely to implement additional tax increases next year, following last week’s decision to abandon a proposed income tax hike, according to David Zahn, Head of European Fixed Income at Franklin Templeton. This decision has already impacted markets, pushing British borrowing costs higher and raising concerns over the government’s fiscal credibility.

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Government Fiscal Strategy and Market Reaction

Investors widely regard income tax increases as the most effective way for the U.K. government to reduce its fiscal deficit and safeguard public finances against economic shocks. In lieu of a direct income tax hike, the government has explored raising smaller taxes. However, according to Zahn, this approach may not be sufficient to stabilize Britain’s debt levels in the long term.

“I do think this is going to be repeated next year; I don’t think this is a one-off,” Zahn told reporters. He also suggested that Finance Minister Rachel Reeves may not retain her current role in the coming year, highlighting potential political instability surrounding fiscal policy.

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Implications for Income Tax and Other Measures

Raising taxes next year will likely prove more challenging, as the government has fewer alternative measures to deploy. Zahn emphasized that an income tax increase could be back on the table, depending on the fiscal pressures Britain faces. He warned that the lack of a concrete plan to reduce debt remains a key risk for markets.

“They don’t have a plan of how they’re going to bring finances down,” Zahn stated, referencing Britain’s rising debt levels. This fiscal uncertainty has left many investors cautious about British government bonds (gilts).

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Risks to Gilts and Borrowing Costs

The coming U.K. budget presents a significant risk: if the government fails to meet market expectations, bond yields could rise sharply, forcing a secondary budget adjustment. Zahn noted that 30-year gilt yields, currently around 5.3%, could spike to 6%—a level last seen in the late 1990s.

While such yields could make Britain’s debt unsustainable, Zahn pointed out that this scenario might also present a buying opportunity for long-term investors. The uncertainty surrounding government policy and fiscal strategy continues to weigh heavily on market sentiment.

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Franklin Templeton’s Perspective

Franklin Templeton, managing approximately $1.5 trillion in assets, is closely monitoring Britain’s fiscal trajectory. Zahn’s commentary underscores the growing market concern about policy unpredictability, the potential for higher taxes, and the broader implications for U.K. debt sustainability and investor confidence.

Investors are now evaluating the possibility of tax rises, changes in government leadership, and their impacts on gilts, borrowing costs, and the broader U.K. economy in the coming year.