UK Markets Await Crucial Insights from Autumn Statement
On November 26, the UK will release its annual Autumn Statement, a pivotal moment in the fiscal calendar. This event will feature independent forecasts from the Office of Budget Responsibility (OBR), which serves as the nation’s fiscal watchdog. Chancellor Rachel Reeves must navigate significant economic challenges, notably a projected cut in long-term productivity growth.
Fiscal Challenges Ahead
The OBR forecasts a reduction of 0.3 percentage points in trend productivity growth. This adjustment is larger than analysts previously anticipated, which was a cut of 0.1 to 0.2 percentage points. Consequently, it deepens the fiscal shortfall by an estimated additional £12 billion. The overall fiscal shortfall may reach between £30 billion and £40 billion, factoring in modest headroom of £10 billion.
Impact of Inflation and Wage Forecasts
Challenges are compounded by rising inflation and wage forecasts, along with a recent drop in Gilt yields. These factors might help mitigate some fiscal impact, contingent on OBR’s assessment. Nonetheless, the substantial fiscal gap complicates the Labour government’s commitment to maintaining income tax rates, National Insurance contributions, and VAT.
Potential Tax Increases and Spending Cuts
Chancellor Reeves has hinted that tax rises and spending cuts may be necessary. She attributes the current fiscal predicament to the aftermath of Brexit and the policies of the prior Conservative administration. Labour is likely to tackle the fiscal gap proactively to prevent the threat of future tax hikes as the general election looms.
Considerations for Gilt Markets
The budget’s strategies could relieve some pressure on the Gilt market. Key considerations for both Gilt markets and GBP FX would include any adjustments to fiscal rules by the government. One proposal suggests advancing next year’s fiscal rule change, which would permit a deficit of 0.5% of GDP, potentially easing budget constraints.
- Avoiding significant increases in unpredictable revenues risks troubling Gilt investors.
- A 1 percentage point increase in the basic income tax could yield approximately £8 billion.
- A VAT increase, though not ruled out, would raise revenues but could also lead to higher inflation.
Economic Outlook
The prospect of a tightening fiscal policy could help alleviate some negative impacts on public finances, yet it might hinder economic growth. If severe tightening occurs, it could prompt the Bank of England to implement more substantial easing measures. With a global investment landscape favoring a weaker GBP, we anticipate upward trends for EUR/GBP, targeting a ratio of 0.89 within the next 12 months.
