Autumn Budget economic reaction

Introduction – backloading tightening…

In an ideal world, the contents of today's Budget would have been different. Instead of a smorgasbord of small measures supplementing a freeze in income tax thresholds for a further three years, there might have been a closer look at welfare costs and perhaps a simplification of the tax system. But this is not an ideal world. The OBR downgraded its productivity growth forecasts, weighing on projections of tax receipts. Added to that, the watchdog also had to factor in government U-turns on welfare benefit restrictions, as well as include the costs of the removal of the two-child benefit cap. According to the OBR’s forecasts, today's package results in Rachel Reeves meeting her fiscal mandate with a margin of £21.7bn in 2029/30, well above the £9.9bn forecast at the Spring Statement in March. Here at least, job done. Markets agree, at least for now. Following a jittery few weeks, sterling and gilts have rallied, although both markets underwent temporary sell-offs this afternoon, seemingly as they were initially unconvinced by the Budget details.

One reason for these doubts is that the revenue raising measures are backloaded – the Treasury’s arithmetic shows that the net impact of the Budget is actually modestly expansionary until 2028/29, which leaves them more vulnerable to a reversal than policies that might take effect in April next year. This could introduce an interesting dynamic to monetary policy. Although the net fiscal impact from the measures is a net consolidation of £24.1bn in 2030/31, the absence of tightening measures in the near term fails to provide an argument for lower rates at next month’s MPC meeting, bearing in mind the MPC’s three-year projection horizon. We are still of the view that the Bank of England will lower the Bank rate next month, but today’s Budget means that from our perspective, the case is a little less compelling.

As well as looking towards financial markets, PM Starmer and Chancellor Reeves need to continue to sell their vision to their own party. To enable them to do this, Labour's standing in the opinion polls must improve from a position some 10% behind Reform UK, else Labour will suffer badly at the local elections next May. If this does not happen, Starmer faces a serious threat to his leadership. This would also imperil his Chancellor. Were there to be a change in leadership, markets would likely doubt the government's commitment to fiscal stability, especially as the tax increases announced today bite so far in the future that they could yet be abandoned. Today the government has avoided what has come to be known as a 'Liz Truss' moment. But the Chancellor continues to walk a tightrope, with the added threat that she may run out of rope over the next few months.
 

Measures – deferred tax rises on households

This Budget was very much another fiscal repair job. As the government had forewarned over the previous weeks and months, but going against the spirit if not the letter of its pre-election promises, tax rises are to do most of the heavy lifting to balance the books. Indeed, by FY2029/30, the tax burden will be £26.1bn higher than was previously planned at the time of the Spring Statement. This will more than cover the £11.3bn of additional public spending that year – the majority of which, £6.9bn, is to cover past U-turns on planned welfare cuts, and £4.4bn are new commitments. In contrast to last year's Budget, though, the additional tax burden will fall primarily on households rather than corporates. Whereas higher spending is immediate, another crucial difference from last year is that the tightening is heavily backloaded: the vast bulk of higher taxes will not hit straightaway in the next tax year, but only from April 2028 and beyond.

The single biggest tax raising measure is an extension of the freeze in personal tax thresholds for a further three years to FY2030/31 – so longer than the two years that had been rumoured. This represents a prolongation of ‘stealth’ tax rises that started in 2019 and that have made up the bulk of the extra tax take between FY2022/23 and FY2030/31. By FY2029/30, today’s extension is calculated to yield an extra £7.8bn of additional revenue as nominal wage rises pull more people into higher tax brackets, with further additional revenue to come in FY2030/31 (to £12.4bn).

A second key measure with a delayed impact is the sharp scaling back of tax relief on salary sacrifice schemes for pension contributions: salary-sacrificed contributions to such schemes in excess of £2,000 p.a. will become subject to National Insurance contributions. As a result, more National Insurance will be paid, raising £4.7bn of additional revenue for the Chancellor in FY2029/30. This will take place only from April 2029, so it will make a difference to the projected tax take even later than the extension of the income tax threshold freeze. Although the extra cost will initially accrue to employers, the OBR assumes that they will pass three quarters of it onto their staff, via a mix of lower ordinary employer contributions and lower salaries and bonuses.

Also kicking in only later is the introduction of a new mileage-based tax on the use of electric and plug-in hybrid cars: electric cars will initially be charged 3p and hybrids 1.5p per mile. This will be applied from FY2028/2029 and raise £1.4bn p.a. It is expected that the cost of this new charge will be the equivalent of about half of what fuel duty tax would be for a petrol or diesel vehicle.

Similarly, there will be a 'mansion tax' – or a ‘high value council tax surcharge’ in the official parlance –that will take the form of a targeted hike in council taxes for homes in the current council tax brackets F-H worth over £2m. These will be revalued and taxes raised accordingly, with additional bills ranging from £2,500 to £7,500 per property per year. But revaluation will take some time, so this will only add to bills for affected households from 2028. Even then, this may have a chilling effect on property demand and prices at the top end of the market immediately, throwing a spanner in the works of property chains. In FY2029/30, the OBR expects this to raise an extra £0.4bn.

A few measures though will hit as soon as April 2026. One such measure is to raise the tax rates on dividends, savings and property income. These will now be lifted by 2%pts each, estimated to raise £2.3bn in total in 2029/30, of which over half will come from dividends. Dividend tax rates would, at 10.75% and 35.75% for the basic and higher rates, still not be aligned with income tax rates, but the gap will be narrowed.

Relatedly, the cash ISA allowance will be cut from £20k to £12k a year for under-65-year olds from April 2027. This is expected to have little impact on the tax take. It is hoped, instead, that households could, in part, respond by investing more in other assets including equities, which in the long term stands to benefit their returns more than keeping money in cash. To the extent extra UK stocks are bought, the government may also be hoping to invigorate UK listed markets. Where households decide to save less and consume more instead, this would add to GDP and the UK tax revenue now, albeit at the clear cost of less of a nest egg to draw on later at a time when the stock of household savings is already low.

Corporations have not escaped the direct impact of tax raising measures in the Budget in their entirety. The government will lower the writing down allowance main rate by 4%pts to 14% from April 2026. Although this will be offset in part by the introduction of a new 40% first-year allowance, with this this taking effect already in January 2026, the net impact will still be to raise taxation on some types of investment, raising £1.5bn for the public purse in FY2029/30.

Further measures relate to gambling duty, some of which will take effect as soon as in April 2026 too. Through higher remote gaming duty initially and a new rate of general betting for remote betting a year later, albeit with some minor offsets (bingo duty for instance will be abolished) these are to raise £1.1bn by FY2029/30.

As usual, the Budget contained a spoonful of sugar to help the medicine go down. These sweeteners had a distinct Labour flavour.

First, the government has complied with its backbenchers' demands and abolished the two-child benefit cap from April 2026, lifting an estimated 450,000 children out of poverty by FY2029/30 at a cost to the exchequer that will build to £3.1bn that year. Second, energy costs for households will be lowered temporarily, by the government refunding electricity suppliers between April 2028 and March 2029 for 75% of the charges paid by them under the domestic portion of the Renewables Obligation scheme, a levy to support renewable energy generation that providers currently fully pass onto households via higher electricity bills, and by it ending the Energy Company Obligation, similarly currently an addition to consumer bills. This is anticipated to remove around £150 from annual electricity bills per household from April 2026. Third, fuel duty will once again be frozen, albeit with the five-pence cut of 2022 (supposedly) scheduled to be reversed in a staggered manner from September 2026. Freezing fuel duty continues a costly long tradition and is projected to cost £0.9bn in the medium term. This though will not impart an extra fiscal impulse to growth but merely avoid a hit that would have occurred had fuel duty rates been raised as officially scheduled.
 

Public finances – an improvement, but only later

The combined effect of the Budget measures and the changes to the OBR’s economic forecasts is that the Chancellor is now adjudged to have an increase in the headroom against her main two fiscal rules. The OBR concluded that the fiscal mandate, i.e. that ‘day-to-day spending’ should be covered by tax revenue in 2029/30, is on course to be met by a margin of £21.7bn, against £9.9bn at the time of the Spring Statement in March. In addition, the watchdog concluded that the supplementary target, the ratio of public sector net financial liabilities to GDP is falling in 2029/30, is due to be met by £24.4bn, versus headroom of £15.1bn previously. Taking a measure of risks into account, the OBR assessed that there is a 59% chance of meeting the fiscal mandate (54% in March) and a 52% of meeting the supplementary target (51% in March). The increased amounts of headroom reflect the new tax policies which are partly offset by higher spending. Interestingly the OBR stated that both rules would have been met on the forecast had policy been left unchanged, if by just £4.2bn, in the case of the fiscal mandate.

The new forecasts mean that the amount of headroom against the fiscal mandate is at its highest since March 2022. We would also note though that a third rule, a cap on welfare spending, is also met in 2029/30 though the margin is now marginal at £1.9bn and below the £13.5bn forecast by the OBR at the Spring Statement. This is due to a reversal of the welfare benefit restrictions announced earlier this year, plus a rise in disability caseloads.

Looking at specific fiscal metrics, overall public sector borrowing (PSNBx) so far in 2025/26 has been running above both last year’s levels and the OBR’s forecast in March. Accordingly, it was not surprising that the OBR pushed up its forecasts for borrowing this year to £138.3bn (4.5% of GDP) from £111.7bn. This still represents a reduction from the £149.5bn in 2024/25. Thereafter PSNBx is envisaged to decline gradually to £67.2bn in 2030/31 (1.9% of GDP).

Similarly the current budget deficit (the mandated measure of the deficit) is projected to fall from £52.4bn in 2025/26 (1.7% of GDP), turning to a small surplus in 2028/29, a year later than believed in March. This surplus though increases visibly in 2029/30 (due to the scheduled tax increases) and reaches £24.6bn the following year (0.7% of GDP).

The various debt metrics show a similar path. The targeted measure (PSNFL) increases gradually as a share of GDP through the profile and begins to fall in the reference year (2029/30), in line with the mandate but a year later than envisaged at the Spring Statement.

Overall it is true that the Chancellor’s measures have resulted in an increase in the headroom against the two principal fiscal rules, but this is very dependent on measures that take effect later in the profile, which arguably makes them more susceptible to be changed or even removed.

One last point is that the OBR will in future be asked to assess the progress of the public finances against the fiscal rules just once a year. There will still be two sets of published forecasts however, with the non-Budget forecasts acting as a form of health check of the public finances.
 

Fiscal headroom against primary fiscal rule (OBR forecasts)

Past headroom calculated as %GDP and multiplied by the latest forecasts for nominal GDP in 2029/30. For Nov 2016 and March 2020, the headroom against the proposed fiscal rules is used.
Source: OBR, Investec Economics

Productivity downgrades outweighed by upgrades elsewhere

In the lead up to today's Budget there was much speculation over what the OBR's updated economic forecasts might look like. There was an expectation that the OBR would downgrade its medium-term productivity forecasts, reducing projected tax revenue and necessitating fiscally corrective measures for the Chancellor to meet her fiscal rules. In the event, the OBR opted to downgrade the underlying rate of productivity growth over the medium term by 0.3%pts to 1.0%, which, in isolation, was estimated to lower tax revenues by around £16bn in 2029-30. There is still vast uncertainty over these productivity forecasts however. As such, the OBR also carried out some scenario analysis in which there was a larger boost from AI, pushing potential productivity growth up to 1.5% in the medium term. In this case, the current budget surplus was estimated to reach £74bn in 2029-2030 (compared to the current baseline forecast of £21.7bn).

On the central scenario, softening the blow for the Chancellor were the marginal upgrades to wage growth. This alone boosted estimates of tax revenue from labour income, but these were then amplified by the freeze in tax thresholds over the forecast period, pulling more earnings into higher brackets. Indeed, income tax and NICs receipts were estimated to be £11bn higher in 2029-30 than was estimated in March. When also considering the upgrade to the inflation forecasts (+0.2%pts in 2025 and +0.4%pts in 2026) and a change to the composition of economic growth, the revisions to the economic forecasts, pre-measures, boosted overall tax receipts by a net £16bn.

There are still points of concern however over the economic forecasts. Although GDP growth was upgraded by 0.5%pts this year to 1.5% (now matching our own forecast), it was then downgraded in every remaining year of the forecast period. Furthermore, despite the upgrades to wage growth, real household disposable income is projected to grow more slowly over the forecast horizon: compared to March; growth was downgraded on average by 0.25%pts a year. That consumption growth remains relatively resilient is due to the expectation that the saving rate falls over the period, from 10.6% in 2025 to 6.7% in 2029. If that does not occur, we would be looking at a far weaker set of economic projections, with ramifications for the tax take estimates.

Insofar as government policies are concerned, the OBR judges the measures announced today to have no significant impact on output by 2030. That probably will be taken as a win, given that the measures will represent a fiscal tightening by 2030.
 

Gilts – reassurance from lower long issuance

Today’s rally in gilts, with the 30y outperforming the wider curve by virtue of a 9bp fall in yields was aided by the publication of the updated gilt remit by the DMO, which provided some reassurance over the outlook for future issuance. This update included a revised figure for total 2025/26 gross gilt issuance, which at £303.7bn represented a £4.6bn increase relative to the April update, but marginally lower than consensus estimates of £308.1bn (Bloomberg). Unsurprisingly the DMO’s update reconfirmed its preference for shorter maturity gilt issuance given changes in the structure of market demand and amidst the pressures seen at the long end of the curve this year. It now envisages issuance in the 3-7yr bucket totalling 44% of total sales this year. Meanwhile planned long-dated gilt issuance was scaled back again to 9.5% of the total, a factor which likely supported the 30yr rally.

Beyond the update to 2025/26 issuance, medium-term gross financing needs do not look materially different relative to the estimates published alongside March’s Spring Statement with 2026/27’s illustrative financing requirement just £4.7bn higher at £275.3bn. On average over 2026/27-2029/30 gross financing requirements are £19bn higher, but that is principally due to sizeable uplifts to gilt redemptions in 2027/28 and 2029/30. Reassuringly the government’s cash requirements are only £400m higher on average over the period.

Video: Snap reaction

This article is for general information purposes only and should not be used or relied upon as professional advice. It is advisable to contact a professional advisor if you need financial advice.