Fiscal Restraint in UK Budget Wins Over Gilt Investors, for Now

UK Chancellor of the Exchequer, John Healey, released the Autumn Budget on Wednesday, October 28^th— the first for Prime Minister Andy Burnham. I think of it as a ‘starter budget’ that appears to have won the confidence of bond investors by showing fiscal restraint, even as it holds back on the Prime Minister’s larger ambitions.

Key takeaways

Between a rock and a hard place. The government promised not to raise taxes but needed to limit spending in order to build confidence in its ability to be fiscally disciplined, which is important for containing and reducing borrowing costs. Chancellor Healey promised that the UK would meet the fiscal rule that primary spending will be paid for with tax receipts.

Affordability is front and center. The Budget includes a GBP100 pound household energy payment to 20 million low- and middle-income households. That is a minor expenditure when compared to the fuel subsidies provided in 2022. However, because it is targeted at lower-income households, which typically have a higher marginal propensity to consume, I expect it to have a slightly positive impact on the economy. There is no change in tax on income from employment, and the national minimum wage is increasing. For aspiring homeowners, the Budget creates a First Time Buyer Individual Savings Account (ISA) to help save for a first home and institutes a new equity loan program for first-time buyers.

The Budget looks relatively business-friendly. Small business rates relief increases from GBP12,000 to GBP18,000 pounds, and entrepreneurs get support through measures such as a reduced capital gains tax of just 10% for businesses they help build (with a lifetime maximum of GBP10 million). The bank profit surcharge is only increased to 6%, a relief given fears it would be higher. The government is also re-establishing the Better Regulation Executive to reduce red tape for businesses and workers, and providing more money for the National Wealth Fund to increase investment in growing companies and defense. Also, it looks like local governments will benefit. The Budget gives local mayors a share of income tax, which will increase over time.

Savers may be nudged toward equities. The tax on dividends is not increased. However, the tax on savings income will increase, which could encourage money to move from cash to equities.

Growth outlook seems too gloomy. The Office for Budget Responsibility (OBR) downwardly revised its economic growth forecast for the UK for the next several years. However, its new forecast of 1% growth for 2027 seems too pessimistic to me.

Market reaction, looking ahead

The UK stock market was relatively flat today, while the 10-year and 30-year UK gilt yields eased. I believe the UK has had higher borrowing costs than it deserves for several years, largely because of the Liz Truss budget, and we could soon see an end to that mispricing of UK gilts. The primary deficit (excluding interest costs) is expected to shrink to zero fairly soon, and I expect UK gilt yields to decrease given the UK’s relative fiscal discipline compared with countries such as the US and France, which are running primary deficits of about 3%.

Of course, this Budget doesn’t contain Prime Minister Burnham’s large ambitions, such as a national care service and increased defense spending. I think it will likely take his calling an election and showing strong support for his mandate to move forward with sweeping plans, although he has ruled out a snap election in the next 12 months. In the meantime, his upcoming ten-year plan will likely provide insight into his major plans for the future.