UK Budget: Big numbers

The economist view – Melanie Baker, Senior Economist

This was less obviously a Budget for growth than one for public services repair, with a substantial proposed increase in day-to-day fiscal spending and net investment. Going into this Budget, the existing fiscal plans had what looked like overly tight spending settlements implied for ‘unprotected’ departments and with government services struggling in some areas. Extra spending – to some degree – looked sensible. However, this Budget includes very large increases to spending and at the cost of a further sizeable increase in the tax take.

The numbers were big

Large numbers included the extra £40bn of tax raising. There were also very big increases announced in some areas of government spending, especially the NHS, and overall spending (day-to-day plus net investment increases by 2.1% of GDP by the end of the Office for Budget Responsibility (OBR) forecast in 2028-29 compared to the March 2024 Budget). The end increase in the deficit was bigger than I would have expected in light of that sizeable tax raise. In 2027-28 for example, the deficit (public sector net borrowing) is now £72.2bn, up from £50.6bn in the March 2024 Budget (or 0.7% GDP higher).

This a net stimulative Budget

By the end of the forecast horizon (2029-30) the Treasury’ costings indicate that policy decisions will cost a net £33bn (£74bn extra spending offset by £41bn extra tax). Both tax and spending measures build a bit in terms over the horizon but both the increases in both tax and spend come through strongly in the first two years of the forecast already. As before, fiscal policy looks set to get marginally less supportive for growth as the year’s progress.

It was striking how fast the public sector net investment numbers ramp up – with an additional £18.5bn by 2025-26 already. So, one question would be how realistic this is in terms of plans, resources and available labour to get off the ground.

The planned increase in taxation is also very large. Taking the biggest measure for example – the increase in employer national insurance contributions (NICS) – firms could, for example, respond to that by hiring less, restraining pay increases or passing costs on to customers (and the 6.7% increase in minimum wage announced alongside the Budget will also be a lot for some firms to absorb). The OBR are assuming that growth in wages and profits are constrained by the increase in employers NICS.

The fact this event is over is itself probably somewhat positive for activity

Thinking much shorter term though, this first Budget of the new government has been a bit of an uncertain prospect, with messages somewhat mixed in recent weeks and with various potential tax measures and numbers floating around. Although expectations had firmed up in recent days, the fact this event is over is itself probably somewhat positive for activity. For example. there were signs in some of the business survey data of Budget-related uncertainty holding back decisions.

Inflationary

Given this is a net stimulative Budget and that there are increases in duty planned, it makes sense to assume that this Budget increases inflation. The OBR judge that policy measures will likely add to inflation and estimate an impact of around 0.5 percentage points at the peak. The Bank of England (BoE) will make their own judgement, but this isn’t a Budget that – at least at first glance – makes rate cuts more likely.

Main tax measures – a few surprises

There were some surprises – in particular, Chancellor Reeves announced that income tax thresholds would be unfrozen later in the profile (rather than extending the freeze). The increase in Employers National Insurance had been broadly trailed beforehand. She also chose not to raise fuel duty. That said, the overall £40bn increase in tax take was bigger than I’d have expected. Other significant measures announced (all much smaller compared to the NIC change) included efforts to increase tax collection, abolition of non-dom status, applying standard VAT rates to private schools, increasing Capital Gains Tax and including unused pension funds within Inheritance Tax.

The deficit and debt figures look worse

Looking crudely at the OBR figures, the numbers for the deficit and debt look worse than they did in March 2024, though the government would probably argue that they are more realistic given the previous plans included those very tight public spending settlements. By 2028-29 for example, the public sector net debt measure is now 3.0% of GDP higher on the OBR figures and public sector net borrowing (the deficit) is now 1.0% of GDP higher than they were in the 2024 Budget. In line with that, public sector net investment is nearly £30bn higher than it was by that point (or 0.8% GDP).

The underlying GDP forecasts for the next couple of years – that feed those public finance forecasts – look optimistic to me too. Assumptions on net interest payments might also prove optimistic if the gilt market struggles to digest the additional issuance implied by this Budget.

The longer-term trajectory for the UK fiscal finances still looks problematic too, as it does in many places, reflecting demographics and the challenges of an ageing population for public finances.

Forecast risk

It makes sense as a central case to raise the near-term growth forecast a few tenths of one per cent next year given the net stimulus announced, but the OBR expect a peak impact on demand of (only) 0.6% GDP in 2025-26 and think that Budget policies will lead to some crowding out of private activity in the medium term. With inflation likely also a little higher, I expect that the BoE may well cut rates a bit less than they might have done (though I am already only assuming one 25bps cut this year and three cuts next year so will stick with that relatively hawkish profile for now). If the BoE judge that this Budget will increase the economy’s supply capacity, that could act as an offset. However, that impact is likely to be seen over a longer horizon than the two to three years ahead that the BoE normally focus on.

OBR’s take on the impact of measures on public sector net borrowing and current deficit

The asset allocator view – Trevor Greetham, Head of Multi Asset

True to form for a new government, there’s a lot of pain up front, presumably in the hope that stronger growth and easier times will come as the next election approaches. Proposed tax rises of up to £40bn by the end of the parliament are of the same order of magnitude as the estimated shortfall in government revenues due to Brexit, so this budget can be thought of as a fiscal reckoning that was delayed by the pandemic. Keir Starmer has committed not to explore rejoining the EU Single Market or Customs Union, however, and trade policy didn’t even get a mention today. Instead, the government is basing a large part of its growth strategy on rule changes to allow an increase in public investment.

The tax rises are painful but a focus on growth is to be welcomed. If all goes to plan, greater political stability and a more productive economy should support UK-listed companies and the commercial property market over a period in which heady global equity valuations and geopolitical uncertainty could prove troublesome for investors. 

Bouts of higher-than-expected inflation are likely to be part of the solution to work down debt

With the UK’s general government debt to GDP ratio over the 100% mark, much will depend on the willingness of the gilt market to finance increased spending at reasonable rates of interest - not a given judging by the market volatility on Budget Day. Looking at the long term, in common with other developed economies, it will be hard to avoid a steady increase in debt burdens as population ageing gathers pace, especially if birth rates remain low.

Bouts of higher-than-expected inflation are likely to be part of the solution to work down debt, as we saw in the post-War period. Long-term savers can look to mitigate this risk by investing directly in commodities like gold and oil as part of a diversified multi asset portfolio.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.