UK budget overview

The Chancellor has delivered the meat of her budget, and the market reaction has been mildly welcoming. After initially spiking, the bond market warmed to the idea of a larger than expected fiscal headroom for the UK, bond yields are lower across the curve, and the pound has climbed to highs of the day vs. the USD.

The pound is one of the strongest currencies in the G10 FX space on Wednesday, which suggests that the Chancellor has passed a major hurdle with this Budget, and suggests that her measures have fiscal credence with investors for now.  

Of course, sentiment remains fragile, spending could still be subdued, and growth could be weaker than expected, forcing the government to borrow more since there were no concrete measures to cut spending in this budget. However, the £22bn of fiscal headroom has been a big winner for Reeves, as the bond market cheers her bold move to dramatically increase the government’s rainy-day fund.

Stock market reacts to Budget

The stock market is a more vocal critic of the Chancellor’s \\\budget. Although the FTSE 100 and FTSE 350 are higher along with global indices, there are some sectors that are struggling under the weight of the UK’s growing tax burden.

 Homebuilders have seen their stock prices sinjjk, as the mansion tax spooks investors about the future of the housing market. The new mansion tax will not come into effect until 2028 and it could be reversed by future governments, thus, the impact on homebuilders could be short-lived.  Consumer stocks are also lower, as the freezing of income tax thresholds could weigh on spending.

The increase in public spending, including on welfare spending, may be a bitter pill for taxpayers, however, it may quieten restive left wing labour MPs, who surely cannot ask for more in the coming months. We will need to see if this actually happens, as the Chancellor is far from popular within her own party. If she has put the lid on Labour MP demands, then she may not need to come back for more tax next year, which may also have a positive effect on markets.

 Broad tax swipe from Reeves

Other measures in this Budget include the freezing of income tax thresholds for an extra 3 years, higher gambling taxes, the tax rate on dividends is rising by 2%, and there will be a ‘mansion’ tax on properties worth more than £2mn that will be in the form of a council tax surcharge, however, this will not come into effect until 2028. There will be an electric and hybrid vehicle tax per mile, however, that also will not come into force until 2028. By back-loading some of her smorgasbord of tax hikes, the Chancellor will push the UK’s tax burden to a new record high of 38% of GDP by the end of this parliament, up from 34% this year.

Higher near-term borrowing fails to spook markets

 However, the government is planning on boosting spending by an enormous £11.8bn by the end of this parliament. Interestingly, the tax increases included in this budget will kick in later, the OBR forecasts that tax measures will rise to £26.1bn by 2029-2030, with only £0.7bn being raised in the next fiscal year.

This means that borrowing must rise in the near term, and the OBR forecasts that borrowing will rise to £138.3bn for 2025/26 up from its original forecast of £117.7bn. Borrowing will be £112bn in 26/27, £15bn more than expected,  only the 29/30 forecast sees a decline in borrowing to £67.9bn, down from the initial forecast of £74bn.

Overall, the government may be ducking big spending cuts, however, they are boosting spending using tax increases and not borrowing. The bond market might like this, but it could be a big problem for taxpayers and may weigh on the government’s popularity even more. The Chancellor may be out of immediate danger but she is still in shaky  territory that could lead to political volatility. The Chancellor delivered this budget with an approval rating around the same level as Kwasi Kwarteng’s after he delivered the mini budget in 2022.

Grim growth as OBR predicts that real income growth expected to grind to a halt

The outlook for growth is grim. Although the GDP forecast has been upgraded for this year, it declines after that and the OBR’s inflation forecasts have also risen. The freezing of income tax thresholds and stagnant wage growth due to the increase in employer national insurance contributions, means that real income growth will grind to a halt by 2027-2028. This is a concern and could threaten the OBR’s growth forecasts if consumption is impacted, and it is hard to see how it won’t be. Rachel Reeves said at the dispatch box on Wednesday, that her government would put more money into working peoples’ pockets, the OBR is challenging this assertion.

Others measures in this budget include national insurance on salary sacrifice pension contributions above £2,000 per annum, and cash ISA allowances were changed as expected, although pensioners won’t be strong-armed into investing in stocks and shares. The cash ISA allowance will stay at £20k until April 2027, after that, pensioners can still  keep the full cash ISA allowance, while younger people will need to invest £8k of their ISA allowance in to stocks and shares.

Financial market relief after interminable budget

Overall, financial markets are breathing a sigh of relief now that this interminable budget is over. By doubling her fiscal headroom from last year, she may have saved her job and bought the government more time. Of course, the real test will be whether the economy can bounce back after weakness in recent quarters. This broad-based tax raid on working people could end up being a spanner in the works.