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The UK Budget announcement saw no major surprises with a flurry of measures to address cost of living issues, but the macroeconomic measures were limited, as Chancellor John Healey stuck to the “do no harm” approach that was hoped for. The closely watched fiscal buffer shrank as expected and is now forecast to be around £15 billion by 2029-30, around half the average since 2010, down from £23.6 billion forecast in March’s spring statement. The fiscal deficit for 2026-27 is expected to be 4.2%, easing to 1.8% by 2029-30. The growth forecast from the Office for Budget Responsibility improved for 2026 from 1.1% to 1.2%, but 2027 saw a notable downgrade from 1.6% to just 1.0%.
Luiz Inácio ‘Lula’ da Silva won Brazil’s presidential election in a shock result. The left-wing incumbent took 51.8% of the vote in the runoff against the winner of the first round, Flávio Bolsonaro, who took 48.2%. Since democracy returned to Brazil in the 1980s, no candidate who has trailed in the first round has managed to win the runoff. Lula, who turned 81 on Tuesday, will now serve an unprecedented fourth term in office. Bolsonaro initially refused to recognise the result and called for it to be annulled but his party conceded defeat and he subsequently fled the country for the USA. Bolsonaro missed a Supreme Court deadline to surrender his passport in relation to an ongoing corruption and money laundering investigation for which he no longer has immunity from prosecution.
The Federal Reserve left rates unchanged, as expected, in a range of 3.75-4% in a 10-2 vote. The Fed upgraded its view on economic activity from “solid” to “strong” and noted that while inflation remained elevated, productivity growth was “strong”, the jobs market “resilient” and “the accumulation of more information will determine the policy stance appropriate to ensure a timely return of inflation to the committee’s 2% goal”. Fed Chair Kevin Warsh said the rise in borrowing costs over 2026 had tightened financial conditions, but he was “unwilling to call them tight”. He vowed to continue administering “new monetary medicine” to bring inflation under control and reiterated they had “not achieved price stability” and that “if you think we’re tolerating some inflation targets somewhere in the twos, let us disabuse you of it”.
There has been an easing in government bond market stresses after France avoided a downgrade from the Moody’s ratings agency, with the country held at Aa3 with a negative outlook. Moody’s said slower growth and a higher deficit have pushed France’s debt burden higher than previously expected, with bond yields rising faster than expected. France’s rating is seven levels above ‘junk’ and on the same level as the UK. Last weekend again saw large-scale protests across France, though a strong police presence and poor weather appear to have helped avoid a repeat of the violence and looting of the previous weekend. Meanwhile, the French parliament continued to debate the main budget bill this week. The bill proposes a reduction in the deficit from 5.4% this year to 5.0% in 2027. Moody’s said their baseline assumption is that a deficit-reducing budget will eventually be adopted, possibly by decree.
Market Movers
The surprising outcome to the elections resulted in significant moves in Brazilian assets at the start of the week. The consensus view was that having led in the first round at the start of the month, a victory for Flávio Bolsonaro was highly likely. Brazilian equities slumped, with the main index down as much as 17%, while the Brazilian real collapsed by over 8% against the US dollar. Government bond yields spiked to over 15%.
A combination of additional spending promises and an aggressive social media campaign clearly inspired voters who failed to turn up in the first round and resulted in Lula receiving 4.4 million votes more than Bolsonaro.
Winning the election to serve a fourth term for Lula will bring fresh challenges. The naming of the finance minister will guide markets as to how seriously Lula takes the fiscal challenges ahead. With a debt-to-GDP ratio of around 82% and a fiscal deficit of around 8% this year, Brazil’s fiscal backdrop is weak. The country cannot outgrow the pace of debt growth, so something needs to change. Markets were betting that Bolsonaro would be far faster to address the deficit than Lula, which in turn would allow the central bank to cut interest rates from the painful current level of 13.75%.
Significant reform is needed in a country where 90% of government spending is mandatory, leaving limited scope for discretionary spending cuts. Markets are, for now, taking the view that Lula is not the man to deliver these reforms. Time will tell if he can once again prove markets wrong. We have been here before; markets collapsed when Lula won his first election in 2002, but pragmatic economic policies, and a commodity boom, led to a golden era for Brazilian assets. Delivering such an outcome this time round, particularly with both houses of Congress controlled by the right-wing opposition, will be a huge challenge.
The Investment Lens
The UK’s Budget marked a departure from those of the past two years under the Labour government, when there has been a significant focus on the fiscal buffer and notable tax rises. In contrast, John Healey has delivered a ‘holding’ budget, arguably with larger policy announcements yet to come on energy reform, the Prime Minister’s ‘10-year plan’ and the UK-EU summit next month. In addition, the spending review next year is expected to see measures to address welfare reform, as well as ensuring the commitment to spending 3% of GDP on defence by 2030 can be met. The government faces significant financial challenges in the future, not least on welfare payments and servicing debt. Welfare spending is expected to rise by almost £100 billion between 2025-26 and 2031-32 to £431 billion.
While the UK deficit is expected to be the lowest in the G7 by 2029-30, higher interest rates mean the servicing of debt will continue to rise, reaching £160 billion a year, or 4.2% of GDP by 2031-32. This figure was ‘only’ 1.7% in 2020. The government remains constrained by the 2024 manifesto commitments not to raise the major taxes that make up the vast majority of government revenues; as such, significant spending cuts, including addressing the welfare bill, higher taxes and higher borrowing will still be needed at some point. Reaching a balanced budget by the end of the OBR forecast horizon will still require steep spending cuts, which appear unlikely given the electoral cycle.
The collective ‘shrug’ in financial markets in reaction to this budget suggests it has been a success in avoiding the dramas of recent years, but it leaves major policy announcements aimed at delivering stronger economic growth and addressing unsustainable spending trajectories for another day.
