Key Takeaways
- The UK Budget was a non-event for markets, with the major fiscal decisions deferred to next year’s Spending Review.
- Growth remains the central challenge, with the OBR forecasting GDP growth of 1.2% this year and just 1.0% next year.
- Fiscal headroom has been reduced to around £15 billion, roughly half its post-global financial crisis average, leaving limited room for error if borrowing costs rise.
- Welfare spending is set to rise by around £100 billion to approximately £431 billion by 2031-32, while debt interest costs are expected to reach £160 billion a year.
- Clarity on defence funding, welfare reform, closer EU ties and the Prime Minister’s ten-year plan will matter more to investors than this Budget.
Last week’s UK Budget proved, as expected, to be a non-event for financial markets. Rather than tackling the major macroeconomic decisions facing the UK, it deferred them. In our view, the most consequential fiscal choices still lie ahead, and investors should look beyond this Budget to the policy milestones that will follow.
The policy announcements were weighted towards cost-of-living measures rather than the structural decisions required over the coming years to bring the deficit further under control and address the trajectory of welfare spending. Those decisions are more likely to be taken in next year’s Spending Review, which we view as the more significant fiscal event.
Defence presents a further challenge. Chancellor John Healey reiterated the government’s commitment to a defence spending target of 3% of GDP, but how this will be funded remains unclear. In parallel, this month’s EU summit will be closely watched. Prime Minister Andy Burnham has signalled a desire for closer ties with the EU, raising the prospect of further movement towards the bloc after the next general election. In the interim, a closer relationship with the UK’s largest trading partner would be a clear positive for economic growth.
Growth remains the central issue. The Office for Budget Responsibility (OBR) forecasts UK GDP growth of 1.2% this year, a modest upgrade, slowing to just 1.0% next year. Growth at these rates is insufficient to ease the fiscal pressures facing the government. The Prime Minister’s forthcoming ten-year plan is expected to address this weak outlook, and closer trading relations with the EU represent one of the more obvious levers available to lift the UK’s longer-term growth potential.
On the Budget arithmetic itself, fiscal headroom has been drawn down, consistent with the principle that buffers should be deployed during more difficult periods. Headroom now stands at around £15 billion, roughly half the average since the global financial crisis. With government spending already stretched by the higher cost of servicing debt in a higher interest rate environment, there are clear risks to these numbers. Equally, should borrowing costs decline, headroom could prove larger than currently forecast.
The deficit trajectory remains encouraging. The IMF recently commended the UK government on the pace at which the deficit has been reduced, and borrowing is projected to fall to 1.8% of GDP by the end of the decade. However, this path implies substantial spending restraint. Much of the adjustment from Rachel Reeves’s Budgets over the past two years was back-loaded, meaning significant spending cuts are likely to be required in next year’s Spending Review.
Welfare is the key pressure point. According to OBR forecasts, welfare spending is set to rise by around £100 billion by 2031-32, taking the annual bill to approximately £431 billion. Over the same horizon, the OBR expects debt interest costs to reach £160 billion a year. Determining how to fund these commitments and delivering the welfare reform needed to reduce the bill or at least slow its growth, represents a major challenge for the government.
Overall, this was a holding Budget. Firmer policy announcements are needed on defence spending and welfare, alongside greater clarity on the Prime Minister’s intentions for the EU relationship and the broader ten-year plan, which we hope will support stronger growth. The market’s muted reaction will likely be welcomed by the government, but more will be required to address both the spending bill and the UK’s growth outlook. It is these forthcoming decisions, rather than this Budget, that we believe will prove more consequential for investors.
