The Budget announcement unfolded amid unprecedented leaks, with the Office of Budget Responsibility’s forecasts circulating before the Chancellor’s speech. Contrary to fears of severe austerity, the fiscal stance was less restrictive, though the Chancellor opted to create additional headroom under her primary fiscal rule. In the round, markets gave the Budget a modest thumbs up, political risk remains an ever-present factor in the safe delivery of the government’s plans to grow the economy and shrink the deficit, particularly as next May’s local elections come into focus.
The net fiscal tightening of £11.7 billion (0.3% of GDP) for 2029/30 was far smaller than the £25 billion anticipated by most analysts. This outcome was shaped by the Office for Budget Responsibility’s adjustments: while productivity growth was downgraded by 0.3 percentage points to 1%, upward revisions to near-term growth, wages and inflation forecasts allowed the Chancellor to maintain compliance with her fiscal rule, albeit with a slimmer margin of £4.2 billion compared to £9.9 billion in March. Still, this margin exceeded consensus expectations by roughly £14 billion. Reeves went further, boosting headroom to £21.7 billion - above both market forecasts and her own earlier projections – signalling a deliberate effort to reassure Gilt investors.
The tightening will rely on a £26.1 billion increase in tax revenues by 2029/30, offsetting a £11.3 billion rise in spending, in addition to U turns on disability allowances and disability benefits, the centrepiece of which is a welcome move to fund special educational needs and disabilities centrally from 2028, at a cost of £6bn. Key revenue raising measures include freezing income tax thresholds from 2028/29 (£8.3 billion) and raising National Insurance contributions on salary sacrifice pension schemes (£4.7 billion). A high-profile council tax hike on properties over £2 million will garner a lot of attention but will only raise £0.4 billion. These changes begin in 2027/28 and intensify over time, reversing much of the fiscal loosening from last October’s Budget. Consequently, borrowing will remain close to the previous Conservative government’s plans, but both taxes and spending will represent a greater proportion of GDP.
After initially coming under modest selling pressure, the Gilt market eventually welcomed the larger headroom, which reduces perceived fiscal risk, and ten-year gilt yields fell to 4.42%, a few basis points lower on the day. Looking ahead, the Budget is likely to weigh on GDP growth, reinforce disinflationary pressures, and accelerate monetary easing. Given this, we expect the Bank of England to cut rates from 4%. to 3% (with the risk they do more) next year. This is below the 3.5% trough priced by markets and should generate further gains in short-dated and intermediate maturity Gilts, with the ten-year sector trading through 4.25%. However, this trajectory hinges on political stability which cannot be taken for granted in the febrile Westminster environment.
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