Budget preview: Do no harm…

Major decisions are likely to be delayed

There seems little scope for major shifts in expenditure in the Autumn Budget. Accordingly, it seems unlikely that Mr Healey will set out a ledger containing major spending commitments, for example on defence, and detail how these are going to be paid for. Instead he seems likely to identify a number of short-term spending priorities, such energy price relief for the most vulnerable households. These policies are likely to be financed by modest increases in taxation in individual areas. This means the stance of the Budget is broadly neutral relative to previous plans, and maintains the path of gradual fiscal tightening planned under ex-Chancellor Reeves to try to reinforce the government's fiscal credibility. Decisions on major programmes look delayed until next year and for his first Budget we expect Mr Healey to follow the finance minister's equivalent of the Hippocratic oath, namely 'do no harm'.

Is there any advantage in kicking the can down the road? Perhaps. First, this would allow time for a proper integration of the Government's new spending priorities and revenue-raising capabilities by virtue of a new Spending Review. Second, there is rarely much appetite within the parliamentary Labour Party for reductions in welfare spending. However, the publication of several reports on various aspects of the welfare system over the next few months, including Alan Milburn's finalised report on young people and work, may give the Chancellor political cover to make some savings via reforms to welfare payments. Third, war in the Gulf has resulted in a combination of firmer gilt yields, higher interest rate expectations and elevated inflation expectations. This is an unhelpful cocktail which will push up the Office for Budget Responsibility's forecasts of government borrowing over the medium-term, thus reducing the amount of headroom which the Chancellor has in meeting his fiscal rules and thereby limiting his spending capabilities. But the squeeze on the headroom may only be temporary if the war comes to an end before long. Fourth, the reference year for the fiscal rules is due to be moved next year from FY2029/30 to FY2030/31 as it will become the third year of the forecast. On the basis of the OBR’s Spring Forecasts (SF) in March, this would then improve Mr Healey’s room for manoeuvre by £6.7bn.

Not much headroom (yet?)

The change in Prime Minister and Chancellor has not resulted in any modifications to the fiscal rules, which remain firmly in place. The two principal rules are:

• The fiscal mandate, or the ‘stability rule’, which says that the current budget (revenue less day-to-day spending) should be in surplus in FY2029/30 (until that year becomes the third year in the projections, at which point the mandate will shift to a three-year rolling target).
• The supplementary target, the ‘investment rule’, which stipulates that debt (based on the Public Sector Net Financial Liabilities measure) should be falling as a share of GDP by FY2029/30.

At the March Spring Forecast, the OBR did not offer any official analysis of the prospects of the (then) Chancellor meeting her fiscal rules. However, the forecast numbers showed that both of these rules were on course to be met with implicit margins, or headroom, of £24bn on the fiscal mandate and £27bn on the supplementary target. In terms of short-term progress towards the fiscal mandate, data on the public finances until August 2026 showed that the current budget deficit was falling compared with the equivalent period a year ago. However, the shortfall was running modestly above (£1.0bn per month) the OBR's illustrative monthly path. This is a relatively small difference which could easily be revised away. But looking towards FY2029/30, an assessment of the increase in implied gilt yields, Bank rate and inflation data since March suggests that up to £15bn of the Chancellor's headroom could be whittled away. Significant though this sum is, we do expect Healey to make the case that headroom is a buffer that can and should be used at times when unexpected shocks hit. This is all the more so if there is a prospect that the underlying cause – the Middle East conflict – might be resolved relatively soon, which could then unwind the energy squeeze over the coming years. Tightening policy now and unwinding this later would then introduce unnecessary volatility in fiscal settings that could be avoided by simply letting the size of the headroom buffer fluctuate.

Macroeconomic pressures continue

Of course, other macro factors will also determine the OBR's medium-term forecasts of the position of the public finances. An important factor will be the OBR's assessment of productivity trends. A year ago, speculation was rife that the watchdog would lower its productivity growth assumptions aggressively, due to the UK's apparently chronic productivity performance in recent years. In the event, the OBR did downgrade the profile, but only by a relatively modest 0.4% pts per annum. This time around, the question could be whether there is an upgrade to the profile thanks to a recent rethink by the Office for National Statistics (ONS) which has led to upward revisions to the UK's productivity history. These might well carry implications for the OBR's view going forward. However the ONS has not yet published new data beyond 2024 and so the OBR may judge that any favourable revisions to productivity trends will be a subject for forthcoming exercises, rather than next week. This is potentially important as, subject to specific conditions, higher productivity growth could have a materially beneficial effect on the projections of the public finances – the OBR has estimated that an additional 1% increase in productivity levels would reduce government borrowing by £18bn.

Overall, scrutinising the public finances supports the argument that Chancellor Healey will announce a limited set of measures this time and insert a placeholder for next year’s Budget. This will be in the hope that conditions are more favourable to raise spending without major increases in taxation, while remaining on course to meet his fiscal rules by a reasonable margin. But although we expect major shifts in policy to be avoided this time, the Budget will of course contain a number of new, if perhaps not radical, policy decisions.

Without being able to bank on a much rosier macro picture to bolste tax receipts, and against the backdrop of grumbling global bond markets, any giveaways will need to be funded. Chancellor Healey will be well aware that demonstrating his fiscal probity to markets is mandatory – Kwasi Kwarteng’s ill-fated ‘mini’-Budget in 2022 has seen to that. Ultimately, at this Budget, we expect this to mean additional tax rises much more than extra spending cuts.

After all, as far as spending cuts are concerned, we note that the existing fiscal plans Healey inherited from Reeves already implied some fairly significant real-term expenditure reductions for departments outside healthcare and defence, especially in the latter years of the forecast horizon. There is some scope for making these starker still by not uprating fully for now higher inflation, but this could risk pushing beyond the boundaries of what bond markets would regard as credible. We suspect that, for this reason, that Healey and Burnham will resist the temptation of resorting to what the Iinstitute for Fiscal Studies has previously termed the ‘fiscal fiction’ of pencilling in spending cuts for future years that are so steep as to be implausible.

Macro forecasts – is it too soon to revisit the productivity puzzle?

As is customary for a major fiscal event, the OBR will also publish updated macroeconomic forecasts next week, which will play a key role in shaping its latest public finance projections. The OBR tends to be cautious in making big changes to its economic projections unless there is a clear need to do so, but we imagine there will be some tweaks at the margin.

It is highly likely that the OBR will upgrade its inflation forecasts for this year and next. Back in March the OBR thought annual CPI inflation would be 2.3% this calendar year. Year-to-date inflation is tracking at 2.9% year-on-year, meaning a vast improvement would be needed in the last four months of the year to reach the OBR’s forecast. Considering Brent crude prices are currently tracking at $105/bbl, this seems extremely unlikely. In a similar vein, we imagine that next year’s CPI forecast will be bumped up from the 2.0% predicted in March. Our own 2027 inflation projection is 3.3%.

On a more encouraging note, we imagine that GDP growth will also be upgraded, at least for this year. Despite the more challenging geopolitical backdrop, the UK economy has consistently surprised to the upside this year (on the monthly numbers, GDP growth has surpassed consensus expectations in six out of the eight months that we have data for so far this year). 1.1% annual growth now looks too low.

The jury is out on the GDP forecast looking further ahead, however. Much of this will boil down to the OBR’s judgement on productivity growth. In the past, the OBR has come under some scrutiny for its productivity forecasts, in that it had for some years been overoptimistic on future productivity growth. Recent revisions from the ONS suggest that the OBR might have been closer to the mark than first thought though. It was revealed that the ONS had been overestimating hours worked, in part due to not adjusting correctly for holiday leave taken. When implementing the new lower hours worked data, labour productivity, as measured by output per hour worked, looks much healthier. The ONS now estimates productivity to have grown by 1.3% p.a. in the decade after the Global Financial Crisis (2009-2019) rather than 0.7% as was previously estimated. Coincidentally, productivity growth of 1.3% was what the OBR was forecasting over the longer term in March 2025, before downgrading this at last year’s Budget. The latest OBR forecast has longer-term productivity growth at 1.0%.

The OBR might be hesitant to revise its estimates back up to 1.3% next week though – we imagine it will instead prefer to wait for the ONS to release the complete data set under the new methodology (the current data only run up to 2024, estimates for subsequent developments will not be published until mid-November). An added complication is that the OBR might well choose to adjust down its forecast for hours worked at the same time as boosting productivity, leaving the net effect on potential output growth, and therefore future predicted tax revenues, unclear. The OBR might opt to deal with this at a later date, when they have a more complete data set. Separately though, and more helpfully, the OBR might still want to tinker with its productivity forecasts if it is now more convinced than previously that the widespread adoption of AI in businesses will lead to higher productivity in the future.

Lastly, we imagine the OBR will rethink the average earnings forecasts. So far this year total average weekly earnings growth is tracking some way above the OBR’s projections, making an upgrade to at least the 2026 number likely. There is a bigger question mark over whether the OBR thinks there will be a wage response to higher inflation today though, which will have implications for the expected tax collected from labour income.