The Week Ahead: Budget kicks the can, but offers stability
Well, after two months of intense speculation and warnings of Ҵýtough choicesҴý, it turns out the biggest impact of the 2025 Autumn Budget will probably be the uncertainty all that speculation generated. Last weekҴýs announcements will have virtually no impact on the economy next year, despite the big headline numbers. That does give a degree of stability, but it also means thereҴýs little reason for the Bank of England (BoE) to cut interest rates further or faster.
ItҴýs now clear Rachel Reeves managed to pull off raising £26.1bn in taxes and without breaching her manifesto, spooking financial markets, denting growth or pushing up inflation next year. That was no easy task and deserves credit.
She managed this through two surprises. First, the economic forecasts were much better than expected. The Ҵýpre-measuresҴý forecast, which shows the baseline scenario under current policies before any updates, was just £6bn worse than in March. ThatҴýs significantly better than the £20Ҵý30bn downgrade most people were expecting. This was because even though the OBR downgraded its estimate of productivity growth it was largely offset by increases in its forecasts for wage growth and inflation, which are big positives for tax receipts.
Second, almost all the tax increases are backloaded to the end of the decade. Of the £26.1bn headline increase in taxes, just £0.7bn of them come into effect next year Ҵý the very definition of kicking the can down the road.
Another surprise was the financial marketsҴý positive reaction. WeҴýd warned that a significantly backloaded Autumn Budget would not be credible and that financial markets may react badly. Indeed, we have our doubts that the government will follow through on its promise to significantly raise taxes in an election year.
But, gilt yields fell from 4.60% before the Budget to around 4.43% now in a sign of market approval. Our best guess is that markets were more worried about a repeat of last yearҴýs inflation-boosting Budget or a bad reaction from Labour MPs, which couldҴýve seen Rachel Reeves replaced with someone more spendthrift, than the backloading of tax rises. In addition, more than doubling the fiscal headroom to £22bn means that, even if all those promised tax rises donҴýt actually appear, then the Chancellor will still meet her fiscal rules.
What does the Autumn Budget mean for interest rate cuts in 2026?
The combination of better-than-expected forecasts and backloading of tax rises means thereҴýs virtually no impact on the economy next year from the measures announced last week. In fact, thereҴýs a mild positive impact as we get £0.7bn in extra taxes, but £7bn of extra spending. That should add about 0.1% to demand.
However, the OBR forecasts donҴýt make pretty reading. The institution downgraded its growth forecasts for every year after this one and revised up its expectation for inflation. WhatҴýs more, it expects annual growth in real household disposable income, the best measure of consumers' spending power, to average just 0.4% a year in this parliament due to low productivity and tax rises. ThatҴýs the second worst on record behind the previous parliament. That will not set a good foundation for a rebound in consumer spending.
Stronger growth in the near-term means economic pain will be delayed. However, it also reduces the chances the Monetary Policy Committee (MPC) cuts interest rates next year further than weҴýd expected. Admittedly, the OBR expects inflation to average 2.5% in 2026 and government policies are set to reduce inflation by around 0.3ppts. While last yearҴýs regulated price hikes will persist into Q1, initially keeping the inflation rate higher at the start of 2026, inflation will fall below 2.5% for the rest of the year. The MPC will most likely look through such one-off downward impacts and focus instead on underlying inflation, which will likely be stickier. As a result, we maintain our call for interest rates to end next year at 3.5%.
What are the risks from the UK Autumn Budget?
The Budget has removed some imminent risks, such as a financial market meltdown or leadership challenge Ҵý even if the Chancellor herself hasnҴýt avoided scrutiny because of claims she overstated the poor state of the UKҴýs public finances. But, its measures will give us some much-needed stability next year. WhatҴýs more, if the bigger fiscal buffer prevents another round of confidence-sapping speculation this time next year, then that will be a major positive. It also puts the UK on a path to more sustainable public finances, which is more than most countries can claim. Whether the government sticks to it is another question.
But, itҴýs also raised some additional risks. The most obvious is that worries about the Budget (apparently largely unnecessary) cause growth to slump in Q4. Another is that tax receipts underperform the OBR forecasts, which results in the need for further tax increases in the next couple of years. Perhaps most importantly, there were also no new measures announced in the Budget geared towards boosting the UKҴýs long-term growth rate, despite the governmentҴýs rhetoric. This sentence from the is telling: ҴýWe have assessed that none of the policy measures in this Budget have a sufficiently material impact to justify adjusting our post-measures potential output forecast."
WhatҴýs more, the government still needs to find a way to raise defence spending further. Indeed, with little willingness to curb spending and no signs that the underlying causes of slow growth will be addressed any time soon, weҴýre likely facing another big tax-raising Budget before long.
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