Key takeaways:
- Budget broadly aligned with expectations, relying on back-loaded tax measures and targeted levies rather than headline rate increases.
- Fiscal headroom increased to GBP22bn, signalling discipline and easing near-term debt concerns, though structural challenges (i.e. high debt, weak growth, and low productivity) remain unresolved.
- Gilts attractive for yield and carry, supported by expected gradual BoE easing and improved fiscal credibility; sterling offers medium-term recovery potential despite near-term volatility; UK equities present selective upside, favouring infrastructure and green investment over consumer-sensitive sectors.
What happened?
On Wednesday, the Chancellor of the Exchequer, Rachel Reeves, delivered her second Autumn Budget against a backdrop of slowing growth, elevated borrowing costs, and persistent domestic political uncertainty.
Chancellor Reeves announced a package of measures aimed at delivering approximately GBP37bn in gross fiscal consolidation by the end of the forecast horizon (FY2030/31): as a result, the tax burden will rise to a record 38% of GDP by the end of this parliament. Taxes will rise by GBP26bn, while spending is reduced by GBP11.3bn.
As expected, the centrepiece of the budget (and the biggest revenue raiser) is an extension of the existing freeze on personal tax thresholds until FY2030/31. This is expected to raise more than GBP8.3bn annually by the end of the decade. While politically sensitive, the thresholds freeze avoids breaching Labour’s pre-election manifesto pledge not to increase headline rates of income tax, value added tax (VAT), or National Insurance Contributions (NICS).
Limitations on pension salary sacrifice schemes are forecast to raise GBP4.7bn with smaller amounts due from electric car charges, higher online gambling duty and council tax surcharges on homes valued at over GBP2bn. The council tax surcharge will apply from April 2028 as a recurring annual levy, structured across four price bands. There will also be a 2-percentage points (ppts) increase on the basic and higher rates of dividend tax, raising GBP2.1bn. Lastly, a cut in the Cash ISA allowance from GBP20,000 to GBP12,000 for under-65s from April 2027 has been announced, aimed at, among others, boosting investments into the local financial market.
Tax measures will account for most of the consolidation effort. Spending cuts are modest and largely backloaded, focused on departmental spending freezes and minor adjustments to investment plans. These will be largely offset by some large elements of extra welfare spending (e.g. the scrapping of the two-child benefit cap), and spending on cost-of-living support (e.g. VAT cuts on energy bills, a partial continued freeze on fuel duty, and adjustments to energy price caps).
The budget announcement was marred by the unintentional early release of new growth and borrowing projections from the Office for Budget Responsibility (OBR). These increased expected GDP growth in 2025 to 1.5%, but downgraded growth forecasts for subsequent years. Productivity growth forecasts were also reduced by 0.3ppts to 1% a year, adding further to fiscal pressures: the OBR’s prediction is that this would have implied (ceteris paribus) GBP16bn less in tax receipts by FY2030/31, but inflation (revised upward in the new forecasts) and threshold freezes will more than offset this. Inflation is now forecast at 3.5% in 2025 (up from 3.2%) and 2.5% in 2026 (up from 2.1%). Growth in 2026 is projected at 1.4%, down from 1.9% in March, with average growth over the forecast period at 1.5%.
Public sector net borrowing is expected to be GBP138bn (4.5% of GDP) this year, falling to GBP67bn (1.9%) in 2030/31. On the government’s preferred metric, public sector net financial liabilities, debt-to-GDP is projected to stabilise around 83% by the end of the decade. The OBR expects overall gross Gilt issuance to peak in FY2027/28, followed by a slight fall: it however highlights how allocations have become increasing skewed towards short and medium maturities and the risks this implies.
The OBR reckons that Chancellor Reeves now has a primary “fiscal buffer” (i.e. flexibility on revenues/spending) GBP16bn in the current fiscal year (up from an estimated GBP9.9bn in March) and GBP21.7bn by the end of the forecast period. This is still low by historical standards but higher than what the market expected, providing some relief to bond investors.
What does it mean for investors?
The government’s primary objective with this Budget was to strike a delicate balance between market concerns over debt sustainability and domestic political commitments. Public sector net debt is approaching 100% of GDP, and interest costs are expected to remain elevated well into the next decade. This has heightened investor scrutiny over how the government plans to stabilise debt without undermining growth or fuelling inflation. Earlier this year, these concerns drove the 30-year gilt yield above 5.6%, its highest level in nearly three decades.
The Chancellor’s response has been to rely on back-loaded, tax-based fiscal consolidation while honouring Labour’s pledge not to raise headline rates of income tax, VAT, or NICs. This constraint has led to measures such as extending the freeze on personal tax thresholds and introducing targeted levies on wealth, property, and consumption. While these steps will generate additional revenue, they do so gradually, leaving fiscal buffers thin by historical standards. Nonetheless, the larger-than-expected increase in fiscal headroom signals discipline and adherence to fiscal rules - an outcome welcomed by markets.
Indeed, despite the chaotic early release of OBR forecasts, at the time of writing gilt yields are falling by 3bps–8bps across the curve, while sterling firmed modestly with GBP/USD at 1.32 (+0.48%) and EUR/GBP at 0.8764 (-0.24%), reflecting investor relief over improved fiscal headroom. The Budget did not materially alter the case for monetary easing and markets moved to price a slighter higher chance of a Bank of England (BoE) rate cut in December (at 92% vs 88% the day before). In this context, we remain comfortable with our forecast for the BoE’s key rate to be gradually lowered by a total of 50bps to 3.5% by end-2026 due to slowing inflation and deteriorating growth dynamics/increasing unemployment.
Over a 12-month horizon, we maintain a constructive outlook on UK assets with 10-year gilt yields forecast at 4.20% for end of next year. Expected looser monetary policy should steepen the yield curve, but 10-years gilts remain attractive from carry standpoint. We expect GBP/USD to recover gradually over the medium term implying some limited upside from current levels. Against the EUR, we expect EUR/GBP to ease modestly over the medium term as UK fundamentals stabilise, again implying a gradual improvement in sterling’s relative position.
UK equities face a mixed outlook. The FTSE 100 has delivered strong year-to-date gains, and we see some low single-digit upside from here. Domestic sectors sensitive to consumer demand may remain under pressure from fiscal tightening, while infrastructure and green investment themes could benefit from targeted spending. Two potential positives for the FTSE 100 include the Chancellor’s plans to encourage ISAs to be used for investment purposes from 2027 onwards and the rumoured Stamp Duty Reserve Tax exemptions for UK listings over the next three years. These are expected to favour Financials, which dominate the UK stock index.
Concluding and assessing risks, this budget buys the government some time and has been positively perceived by the market but does not resolve the structural challenge provided by high debt and low economic growth. The potential for market volatility remains high due to the UK fragile “twin deficits” (fiscal and current accounts): political risk and fiscal discussions are expected to remain dominant themes through 2026 and likely beyond.
