UK Budget: Near-term giveaways, medium-term takeaways; still difficult decisions ahead

The economist view

In many ways, this was the Budget expected by many. It did not seem designed to ‘rock the boat’ and it stuck reassuringly to the fiscal rules. The UK is still on a path of fiscal consolidation and there is still quite a lot of fiscal tightening planned in the years ahead. However, some of the big issues have been pushed back and will need to be addressed – including at next year’s Spending Review. These include the need to fund defence commitments and softening the large implied future cuts in real terms day-to-day departmental spending.

There was some reduction in fiscal headroom (notably down to the £15bn that press reports had indicated would be acceptable to the market), largely reflecting that higher inflation and higher bond yields have worsened the fiscal outlook.

That reduction in headroom implies more borrowing (as does increased funding for the government’s national wealth fund and the decision to make some additional time-limited giveaways).

There were a few sizeable spending measures in this Budget, some of them pre-announced. Looking at Treasury costings, compared to March, there is £7.6bn of additional support in the near-term (mostly temporary spending increases or temporary tax cuts) but £7.4bn of net tightening by 2031-32 (mostly reflecting what look like lasting medium-term tax measures). We do not expect this Budget to have a significant impact on the way the Bank of England is thinking about the economy or on the probability of near-term hikes (or medium-term cuts).

We do not expect this Budget to have a significant impact on the way the Bank of England is thinking.

Policy changes

There were a number of already announced policy changes that raised spending/lowered the tax take in this Budget. That included the VAT cut on electricity bills and 5p cut in fuel duty (extended in the Budget through to next summer). But there were a lot of measures announced in the Budget which add in the near term (to the deficit) but take away in the medium term. 

Among the most expensive of the additional near-term giveaways was a £100 council tax rebate (a ‘household energy payment’) for those in bands A-D. Among the bigger takeaways were higher tax rates on property and savings income, changing writing-down allowances, temporarily higher taxes on banks, and foreign sovereign investment taxation changes; at first glance spreading the higher taxes across different parts of the economy.

Higher overall deficit, more borrowing in the market

Combining the changed economic backdrop with the decisions above leaves the planned overall government deficit (PSNB measure) higher than it was in the Spring in all years of the projection. The government also announced additional financing for the UK’s national wealth fund. This does not affect the deficit measure that the government uses for their fiscal rules. It does, however, affect the amount the government will need to borrow in the market in the coming years.

Implications for the economy look minimal

Taking the Budget decisions together, this effectively adds a modest amount of support to the economy in the near term compared to previous plans, then modest additional reduction of support later in the forecast. Overall though, the measures announced in this Budget are expected to have a minimal impact on GDP growth. However, there are a lot of changes in this Budget, some of which may have unwanted or offsetting behavioural implications.

The measures are forecast to reduce inflation by 0.22pp at their peak in 2027 Q2, reflecting extended cuts on fuel duty and VAT on household electricity bills, but this is offset by slightly higher inflation in 2028 after the measures unwind.

Fiscal consolidation and difficult decisions still to come

The OBR figures imply a lot of fiscal consolidation ahead.  The change in the cyclically adjusted primary balance is a proxy for the amount of fiscal consolidation. From a deficit of 0.3% of GDP this fiscal year, by next year it is expected to be a surplus of 0.5% of GDP and a surplus of 1.7% of GDP by 2031/32. While the UK at least has a fiscal consolidation plan, some of the biggest decisions have been delayed and headroom to the fiscal rules remains slim:

1. Delayed decisions, even in this parliament: Even within this parliament, the government has kicked plenty of tough decisions down the line. Inflation has eroded the real terms value of existing departmental budgets. Spending would need to be £11bn higher in 2031/32 to prevent day-to-day spending from falling in real terms beyond 2028/29. Departmental funding decisions have been delayed until the Spending Review next year, and the government’s commitment to spending 3.5% of GDP on defence by 2035 remains unfunded in this budget. The OBR estimate that increasing defence spending to 3.5% of GDP would cost around £35bn a year in 2026/27 terms. 
2. Slim headroom: Headroom to the fiscal rules is relatively slim. The OBR put the probability of meeting the current budget rule at (only) 56%, down from 59%. The OBR scenario analysis shows uncertainties around energy prices and modelling assumptions could significantly erode the headroom (see further detail below) and require more tax rises or spending cuts. 
3. Social care and triple-lock reform next parliament: The government has committed to big (expensive sounding) reforms to social care, promised for the next parliament. The Health Foundation has previously estimated that this would cost between £3.5bn and £17bn a year.
4. Longer term challenges: The UK continues to face long-term demographic pressures. An aging population is likely to weigh on tax revenues while adding to spending pressures across health, pensions, social security and social care, increasing risks to longer term fiscal sustainability. From this perspective, planned reform to the triple-lock is positive. However, the proposed reform is relatively modest, not due to take effect until the next parliament and will take time to deliver meaningful savings. Scenarios and sensitivities

Scenarios and sensitivities

Aside from energy prices, there are uncertainties around productivity growth, the strength of the labour market and government borrowing costs, all of which could impact the fiscal position. The OBR has produced a set of scenarios examining the impact of alternative energy prices on the fiscal and economic forecasts. The OBR have modelled a severe scenario that incorporates energy price paths similar to the 2022 Russian invasion of Ukraine. In this scenario public sector borrowing is estimated to be around £6bn more than the central forecast in 2031/32 when higher energy prices would impact the fiscal position through multiple channels (inflation, financial conditions and wages):

Aside from energy prices, there are uncertainties around productivity growth, the strength of the labour market and government borrowing costs.

OBR Economic forecasts

On the economy, the OBR has revised up its 2026 GDP forecast slightly but lowered its forecast for 2027, as higher interest rates weigh on activity. GDP growth is now expected to be 1¼% in 2026, before slowing to 1% in 2027, 0.5 percentage points lower than the March forecast. The OBR judged that the measures announced in the Budget were not sufficiently material to explicitly adjust the real GDP forecast. 

On inflation, the OBR has revised up its inflation forecast, peaking at 3.8% in 2027Q1 before falling back near to target in 2028.

The fund manager view

What a difference 11 months makes. Last years’ UK Budget was mired by policy leaks and U-turns, as Chancellor Rachel Reeves sought to test the bond market’s reaction to potential policy announcements. Not this time though. The prevailing narrative coming from Number 11 Downing Street was one of fiscal discipline and sticking to the fiscal rules. With most of the major policy decisions on spending already pushed back to the Spending Review planned for mid to late 2027, Chancellor Healey delivered on that narrative; even going so far as to state the much-watched fiscal headroom number upfront. At £15bn, this was in line with the pre-Budget consensus forecast. But that is probably where the positive news from this Budget ends; the OBR forecasts real GDP growth next year to be just 1%, down from 1.25% this year, while inflation is now expected to peak at 3.8% in the first quarter of 2027, remain higher for longer, and only return to the 2% target in mid-2028.

The prevailing narrative coming from Number 11 Downing Street was one of fiscal discipline.

Borrowing is also higher than at the March 2026 forecast in every forecast year; £18bn higher in 2026-27, £16bn higher in 2027-28, and roughly £11bn a year higher thereafter. And then there are the significant cuts to real spending that will be required to meet the fiscal rules at the back end of the parliament; around 2.6% per year over the final three years of the forecasts.

In the short term, the Chancellor has demonstrated the UK has a fiscal framework, one which might just about keep the bond markets onside for now. The reality though, is that the framework is highly vulnerable to exogenous shocks and requires some tough political choices given Labour’s manifesto commitments and policy choices. No wonder market participants are now assessing the possibility of an early election.

The Chancellor has demonstrated the UK has a fiscal framework, one which might just about keep the bond markets onside for now

The other major talking point for bond markets surrounded the much-anticipated revision to the gilt remit; how much extra gilt issuance would be needed to meet the UK’s financing needs for the remainder of the fiscal year to end March 2027, and what changes might the Debt Management Office (DMO) make to the balance of financing across the gilt curve?

Gross gilt issuance for 2026/27 was revised higher from £246.2bn to £250.6bn, which at £4.4bn was a little lower than consensus expectations for around £10bn. That announcement was accompanied by a relatively aggressive shift in the issuance profile away from the longer maturities, as the DMO cancelled plans for one medium and three long conventional auctions, plus two linker auctions. Additionally, they replaced a long gilt syndication with a medium. Given how issuance has played out throughout 2026, this had been largely expected by the market.

We have had a long-held view to have a bias towards longer maturity gilts (30-year) on the curve, particularly relative to the belly (10 to 20 year), driven by our views on valuations and supply dynamics. With the curve now sitting at its flattest levels since September 2024, we have started to temper this view. We remain positive on gilts and duration, but with a reduced bias to longs and a greater preference for five-to-seven-year maturity gilts.

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