UK borrowing costs fall as budget ‘doubles fiscal headroom’
Newsflash: UK borrowing costs are falling, after a flurry of news flashes attributed to the Office for Budget Responsibility.
Reuters are reporting that the UK’s headroom to meet the chancellor’s stability rule has more than doubled!
They are snapping that the current budget surplus margin has risen to £21.7bn in the OBR’s new forecasts, up from the £9.9bn forecast in March.
[This is the target for the current budget to be in balance in 2029-30]
Bond investors had hoped to see an increase in the headroom – and they are piling into UK government bonds, driving down the cost of borrowing. The yield (or interest rate) on 10-year gilts has fallen by 5 basis points (0.05 of a percentage point) to 4.44%.
This is an unusual development – the OBR are meant to release their forecasts when the chancellor sits down, not before she’s even stood up.
Reuters are also snapping that the chancellor’s tax rises will bring in £26bn more – and (as feared) the budget regulator has cut its productivity forecast.
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UK OBR ECONOMIC AND FISCAL OUTLOOK: BUDGET TAX RISES RAISE 26.1 BLN STG BY 2029-30
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UK OBR: CENTRAL GOVERNMENT NET CASH REQUIREMENT EX NETWORK RAIL 149.2 BLN STG 2025-26
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UK OBR: CUTS MEDIUM-TERM PRODUCTIVITY GROWTH FORECAST TO 1.0 PCT FROM 1.3 PCT
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UK OBR: FREEZING PERSONAL TAX THRESHOLDS RAISES 8.0 BLN STG IN 2029-30
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UK OBR: NICS ON SALARY-SACRIFICE PENSIONS RAISES 4.7 BLN STG IN 2029-30
Key events
Growth forecasts cut as OBR downgrades productivity view
The accidentally released OBR report shows that growth will be weaker than previously forecast.
Real GDP is forecast to grow by 1.5% on average over the forecast, 0.3 percentage points slower than projected in March, “due to lower underlying productivity growth”.
The OBR says it has (as expected) lowered its estimate:
We have reduced our central forecast for the underlying rate of productivity growth in the medium term to 1.0 per cent, 0.3 percentage points slower than in our March forecast.
The OBR’s new report has now vanished from its website, replaced with a 404 Not Found error. Presumably it will be back at 1.30pm….
In the City, OBR report causes excitement
Jasper Jolly
At the London offices of Saxo Bank on Wednesday morning, observers would have been forgiven for forgetting that Rachel Reeves was preparing to announce her second budget – until the apparent accidental early release of the government’s official economic analysis moved the markets.
The value of the pound immediately jumped after the forecasts showed tax rises of £26.1bn by 2029-30, and growth of 1.5% over the next five years.
Sterling rose briefly from $1.3160 to $1.32, as investors scrambled to digest the leak.
Sitting on the 26th floor of a tower in London’s Canary Wharf financial district, Neil Wilson, investor strategist at Saxo Bank, said:
It’s not a ginormous move, but in a minute it’s a noticeable spike. It has retraced a bit now.
[the pound’s now slipped back to $1.313]
There was general excitement as the Office for Budget Responsibility, the government’s forecaster, accidentally published its full analysis two hours early.
“Boom! There’s your 200-pager,” said Will Marsters, a sales trader, as the full report was published.
OBR: Child benefit cap ended, personal tax thresholds frozen
Astonishingly, the OBR’s latest Economic and fiscal outlook has indeed been published early on the fiscal watchdog’s site. You can see it here.
The report confirms that the two-child limit is being lifted, at a cost of £3bn, which will the OBR says will increases benefits for 560,000 families by an average of £5,310.
There are also personal tax rises with a combined yield of £15 billion in 2029-30.
The OBR says:
These include: freezing tax thresholds from 2028-29 onwards, which raises £8.0 billion in 2029-30 and contributes to around 780,000 more basic-rate, 920,000 more higher-rate, and 4,000 more additional-rate taxpayers by 2029-30 than in the March forecast; charging National Insurance on salary-sacrificed pension contributions, which raises £4.7 billion; and increasing tax rates on dividends, property and savings income by 2 percentage points, raising £2.1 billion.
UK borrowing costs fall as budget ‘doubles fiscal headroom’
Newsflash: UK borrowing costs are falling, after a flurry of news flashes attributed to the Office for Budget Responsibility.
Reuters are reporting that the UK’s headroom to meet the chancellor’s stability rule has more than doubled!
They are snapping that the current budget surplus margin has risen to £21.7bn in the OBR’s new forecasts, up from the £9.9bn forecast in March.
[This is the target for the current budget to be in balance in 2029-30]
Bond investors had hoped to see an increase in the headroom – and they are piling into UK government bonds, driving down the cost of borrowing. The yield (or interest rate) on 10-year gilts has fallen by 5 basis points (0.05 of a percentage point) to 4.44%.
This is an unusual development – the OBR are meant to release their forecasts when the chancellor sits down, not before she’s even stood up.
Reuters are also snapping that the chancellor’s tax rises will bring in £26bn more – and (as feared) the budget regulator has cut its productivity forecast.
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UK OBR ECONOMIC AND FISCAL OUTLOOK: BUDGET TAX RISES RAISE 26.1 BLN STG BY 2029-30
-
UK OBR: CENTRAL GOVERNMENT NET CASH REQUIREMENT EX NETWORK RAIL 149.2 BLN STG 2025-26
-
UK OBR: CUTS MEDIUM-TERM PRODUCTIVITY GROWTH FORECAST TO 1.0 PCT FROM 1.3 PCT
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UK OBR: FREEZING PERSONAL TAX THRESHOLDS RAISES 8.0 BLN STG IN 2029-30
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UK OBR: NICS ON SALARY-SACRIFICE PENSIONS RAISES 4.7 BLN STG IN 2029-30
Stock market rises ahead of budget
The London stock market has opened a little higher today, ahead of the budget.
But really, that’s part of a wider global rally rather than enthusiasm about what will be announced at 12.30pm.
The FTSE 100 index of blue-chip shares is up 27 points, or 0.3%, to 9,637 points, a little closer to the record high (9,930) set earlier this month. Mining companies are among the risers, as investors grow more confident that America’s central bank will vote for a growth-boosting cut in US interest rates next month.
The more domestically-focused FTSE 250 share index is up 0.37%.
Joshua Mahony, chief market analyst at Scope Markets, says:
The FTSE 100 has enjoyed tentative gains at the open, pushing higher in anticipation of a UK budget that finally draws the line under a period of great uncertainty and concern for businesses and workers alike.
The chancellor has already drip fed some of the giveaways, with the minimum wage hiked by 4.1%. It isn’t a great start for those hoping this budget would be less inflationary than her last. After all, the annual CPI figure remains distorted by April’s 1.2% surge as the energy price cap hike coincided with policy measures of higher minimum wage and NI contributions for businesses. Nonetheless, with Reeves promising to bring down the cost of living, there is a hope that this time around we will see some relief to household expenses through reduced green taxes on electricity. From a wider perspective, the recent decline in UK GDP (-0.1%), Rightmove house prices (-1.8%), and retail sales (-1.1%) signal an economy that has withered away under the cloud of uncertainty.
There is a hope that today will mark the beginning of a new phase where that uncertainty gives way to a more expansive phase where lower yields and a BoE rate cut overshadow concerns around the impact of today’s tax hikes.
UK borrowing costs have crept slightly higher this morning, reversing some of yesterday’s fall.
The yield (or rate of return) on a 10-year UK bond has risen by 0.011 percentage points today (or 1.1 basis points), to around 4.5%.
That’s a seriously marginal move – especially as 10-year yields fell by 4 basis points yesterday. A rise in yields indicates that bond prices have fallen, and vice versa.
ING’s rates strategists, Michiel Tukker and Benjamin Schroeder, caution that UK debt (known as gilts) are reliant on foreign investors’ trust to keep yields under control.
They write:
Gilt markets have been quite volatile in the run-up to the budget and more price swings are possible as the details emerge.
Our baseline is one where the Chancellor does deliver the required budget adjustment to meet the fiscal rules and engineer a material fall in the FY2026 deficit, but a sharp rise in yields is possible if either the fiscal consolidation isn’t perceived as sufficient, or if political pressure builds on Chancellor Reeves in the aftermath.
Reeves must avoid ‘cold porridge’ in Goldilocks budget
Patrick Farrell, chief investment officer at wealth managers Charles Stanley, says the chancellor needs to strike a tricky balance today:
“The Chancellor needs to deliver a Goldilocks Budget today – one with just the right balance between supporting growth, preserving fiscal credibility, and not overburdening households or businesses.
It’s a tough ask and bond markets could decide Rachel Reeves has served up a dose of cold porridge for taxpayers while not doing enough to tackle a yawning fiscal black hole. If the fiscal measures are considered too tight, as well as choking off growth, we could see political instability, which would be hard for bond markets to stomach. However, anything too expansionary would risk inflation and unsustainable borrowing.”
Farmers defy tractor ban in budget protest
Farmers have brought their tractors to London today for a budget protest about inheritance tax changes, despite a police ban on the vehicles (see earlier post).
PA Media report that a number of tractors were seen driving through Westminster early on Wednesday, with police stopping around 20 of them in the vicinity.
This included a farmer dressed as Father Christmas, his tractor carrying a large spruce tree and bearing a sign that read:
“Farmer Christmas – the naughty list: Keir Starmer, Rachel Reeves, David Lammy, Diane Abbott, Angela Rayner & the BBC”.
PA Media adds:
Farmers have parked more than a dozen tractors, brought to Westminster in defiance of Met police restrictions prohibiting agricultural machinery from the area, around Trafalgar Square.
They repeatedly sounded the tractor horns while police stood watching, with rush-hour traffic brought to a standstill.
David Gunn, an arable farmer and agricultural contractor from near Sevenoaks in Kent, said he was protesting on Budget day for a number of reasons, including the Government move to put inheritance tax on larger farm businesses.
He said: “Inheritance tax is one reason, it’s going to cripple the farmers, the small family farmers.
“There’s all the other taxes they’ve been putting on us, and the prices we get for our produce and what it costs in the shop, we don’t make any money.
“Then there’s food security, farmers are going out of business.”
He said his message to Government was “sort the pledge out”.
“You said in the manifesto you would look after the farmers, which you totally haven’t, you’ve ruined the countryside,” he said.
Budget build-up: what the experts say
Reto Cueni, chief economist at Syz Group, reckons the government will want to “deliver the right message” to the financial markets with today’s budget.
That, Cueni says, means showing a fiscal consolidation of close to £30bn, likely extending the headroom against the fiscal rules closer to £15bn.
To achieve such an additional fiscal consolidation, the UK government will likely have to increase taxes – but will try to do so in the “non-inflationary” tax areas, such as tax threshold freezes, or smaller changes to pension taxes, higher council taxes or increasing the gambling taxes and reducing capital gain tax exemptions, while also looking to avoid inflationary instruments, such as duties or tax changes that would substantially raise costs for businesses.
The key for the government is to show that over the next 2 years the budget deficit will be reduced and the UK’s debt burden will finally move down, Cueni says, adding:
Therefore, the Debt to GDP ratio in the OBR’s forecast should be lower in the new release. By reducing the fiscal deficit over the next two years, the government can regain fiscal credibility and assure investors that the UK’s government is keeping control of the debt situation.
This would relax tensions in the gilts market and let yields grind lower. That, in turn, would support domestic oriented stocks in the UK’s equity market, namely homebuilders, utilities, or FTSE 250 in general. Otherwise, with a disappointing new budget, gilt yields would likely increase again, pushing domestic oriented stocks down and supporting internationally oriented stocks and (domestic) bank and financial stocks.
Building up the tension, Neil Wilson, UK investor strategist at Saxo Markets, says today will probably bring “the most consequential Budget in a generation”:
It’s make or break for the Chancellor and the embattled Starmer premiership. The litmus test for its success is the bond market reaction.
Wilson identifies key questions that will need answering.
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to what extent are tax hikes going to drag on growth, which is antithetical to a self-declared pro-growth chancellor, which diminishes her ability to hit fiscal rules?
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to what extent are tax hikes inflationary, which deepens cost of living problems and restricts manoeuvrability of Bank of England to cut rates?
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to what degree are forecasts plausible – are they hinged on fiscal restraint in 29/30 that will depend on nebulous welfare reform and spending cuts, the kind of which the govt has signally failed to pass so far?
Simon French, chief economist at investment bank Panmure Gordon, says the downside risk is that the Budget unravels amidst Labour Party factionalism. That could lead the bond market to expect more debt to be issued, and inflation to be higher.
The upside risk is that Rachel Reeves manages to build a firebreak through to the next fiscal event, which would allow UK businesses and consumers to proceed without speculation about further tax rises, French explains.
Some of Labour’s newer MPs have taken to social media this week with some catchy videos to explain the thinking behing the budget.
Dr. Jeevun Sandher, Labour MP for Loughborough, produced one explaining how economic growth, inflation and political risk all influence the cost of borrowing (and why it matters):
But Gordon McKee, Labour MP for Glasgow South, umm ‘takes the biscuit’ with this tasty explanation of debt to gdp ratios…
Plus one on fiscal rules, and why a mansion tax would help:
The pound is marginally higher this morning, as the City awaits the budget announcement.
Sterling has crept up by a tenth of a cent against the US dollar, to $1.3177, a modest move.
It’s also a teensy bit higher (+0.08%) against the euro at €1.138.
The pound has been weakening in recent weeks, ahead of the budget, so the Treasury will be hoping we don’t see a repeat of the plunge after Liz Truss’s mini-budget three years ago.
Francesca Fornasari, head of currency at Insight Investment, has said:
“Sterling’s reaction to Wednesday’s budget remains highly uncertain, but much of the negative news is likely to be already reflected in current valuations. It wouldn’t surprise me to see the currency rally a little on the day once the scope for more bad news is over.
How to keep the bond market happy today
The bond market reaction will be crucial to how the Budget is perceived by investors, reports Kathleen Brooks, research director at brokerage XTB:
Ultimately the bond market wants to see cuts in government spending and revenue generators that do not stoke inflation. However, a higher than inflation rise in the national living wage, along with large spending increases may leave the bond market disappointed.
In the lead up to this Budget, yields have been falling. In the past week, the UK bond market has been the top performer bar the US, and 10-year Gilt yields have fallen by more than 10 bps. However, the bond market is unlikely to tolerate any increase in borrowing in this Budget, or any move from the Chancellor to distance herself from her own fiscal rules.
Fiscal headroom also needs to be higher than the £10bn last year. A figure between £15bn and £20bn could be warmly received by the bond market.
Brooks adds that the Budget needs to deliver three things to keep the bond market happy and sterling stable:
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An increase in fiscal headroom.
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Front loaded fiscal tightening, preferably with spending cuts.
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A firm commitment from the Chancellor that this will be the last time that she uses the budget for tax raids. This could boost spending and confidence in the economy and help boost growth.
Rachel Reeves has also pledged to keep a ‘tight grip’ on the public finances.
In her video address ahead of the budget, the chancellor says:
I will take action to cut our debt and borrowing, by keeping a tight grip on the country’s finances
Ther is nothing progressive, nothing fair, about spending one in every 10 pounds of government spending just servicing the national debt.
UK inflation expectations fall sharply, teeing up date cuts
There’s good news for Rachel Reeves this morning – the British public’s expectations for inflation have fallen sharply this month.
Expectations for inflation over the next 12 months fell to 3.7% in November from 4.2% the previous month, a survey carried out by YouGov for the US bank Citi showed on Wednesday.
Citi said the reading could boost the chances of a December rate cut by the Bank of England’s monetary policy committee (MPC).
Long-term inflation expectations also fell to 3.9% in November from 4.2% in October.
Citi economists say:
“If this downgrade is replicated, both over time and across the various inflation expectation surveys, we think it could challenge the idea prevalent in the MPC that expectations are an ongoing barrier to both a lower terminal rate and a faster pace of cuts.”
UK interest rates have been on hold at 4% since August, but the City broadly expects a cut to 3.75% in December.
