Markets are on tenterhooks over the UK’s budget plans, here’s what’s at stake

The Autumn Budget is always a significant event in the calendar for financial markets, but that has never felt more true than this year, with investors having a laser focus on Chancellor Rachel Reeves’ spending and taxation plans.

Those self-imposed “fiscal rules” — which were set in stone by Reeves last year and which she has refused to tweak — have been accompanied by higher borrowing costs, lackluster growth and U-turns on welfare spending cuts, leaving her with an estimated budget shortfall of around £20-35 billion (around $26-46 billion) and with little choice but to raise taxes to fill that fiscal hole.

Tax rises are seen widely as inevitable because if she were to break her rules — which aim to make sure day to day spending is funded by tax receipts, and to ensure public debt is falling as a share of economic output by 2029-30 — that could cause a ruckus in the gilt market, with the U.K.’s borrowing costs likely to rise as creditors could question Reeves’ self-discipline and grip on expenditure.

Market strategists agree that Reeves must stick to her own rules and that a selection of tax rises are likely in order to placate investors.

They warn that the chancellor will have to go further than that, however, with investors wanting to see measures to cut spending, boost economic growth and reduce inflation, helping the Bank of England continue on a rate-cutting path that could resume in December and into next year.

“Financial markets will grant no luxury to amend or ignore the fiscal rules – and indeed the Chancellor has been keen to stress her commitment to the rules, describing them as “ironclad” in her pre-budget speech on 4 November,” Nomura economists said in pre-budget analysis, noting: “the ultimate judge of the sustainability of the U.K.’s fiscal position will not be a set of arbitrary rules, but markets.”

U.K. economists Robert Wood and Elliott Jordan-Doak at Pantheon Macroeconomics already expect a small gilt sell-off after the budget, expecting that the “reality” of Reeves’ choices will “disappoint expectations.”

“The political rubber hit the road earlier than we expected, with the government ditching an income-tax hike, bringing forward the gilt correction we forecast. But the political situation has also deteriorated more than we assumed, and the Budget is unravelling more as a result, so we raised our forecast for the 10-year yield to end 2025 at 4.65%, and the 30-year at 5.45%,” they noted in analysis Friday.

On Monday, the yield on the U.K.’s benchmark 10-year gilt stood at 4.552% while the yield on the 30-year bond was at 5.364%.

There are significant uncertainties coming up for markets on Wednesday, not only around what Reeves could announce, and how she will meet her own rules, but also around what the Office for Budget Responsibility (OBR) will say when it publishes its forecasts for the economy and public finances on Wednesday.

There had been rumors earlier this month that the Treasury could announce income tax rises at the budget on Nov. 26 (which would have broken an election manifesto pledge) but when that appeared to be shelved by the chancellor, U.K. bond yields spiked, signaling to the government that any big U-turns on revenue-raising measures, contentious or not, would be met with a brutal reaction from investors.

Not knowing quite what to expect or what they’ll get in the budget has made markets nervous, strategists say.

“There is almost unprecedented uncertainty surrounding this year’s Autumn Budget, making it an unusually important risk event for markets,” Matthew Ryan, head of Market Strategy at Ebury, said in emailed comments last week.

“Investors are clamoring for spending cuts, but any savings are likely to be minimal, and markets will punish the government if it breaks its self-imposed borrowing rules,” he added.

“The key will be whether Reeves is able to convey to markets that she has a credible plan to balance the books in a sustainable manner, while also promoting economic growth,” the strategist concluded, noting that “a perceived anti-growth budget that is tax heavy and lacking in clarity on a tangible strategy to restore fiscal equilibrium” would be bearish for U.K. assets such as sterling and gilts.

David Aikman, director of the National Institute of Economic and Social Research, agreed, telling CNBC Monday that “the key thing is that we have a credible budget that puts the fiscal position in the U.K. on a stable footing. That means having sufficient headroom relative to the fiscal rules which means we’re not going to be in this position of repeat fiscal resets in six months or a year from now.”

“The key thing investors will be looking for is the credibility of the package that she delivers, one aspect of that credibulity is whether the measures are very backloaded,” he said, meaning that policy measures are delayed until the later years of the current forecast period, up to 2029 when the next general election is due.

The government has faced accusations that it risks exacerbating market uncertainty and damaging consumer and business confidence by engaging in what the Resolution Foundation described as “excessive kite flying” — with briefings or leaks on potential tax policy changes to see what the public and market reaction is — in the run-up to the budget.

Aikman agreed the “drip feeding” of news around the budget had created policy and business uncertainty but he said the chancellor still had scope to turn that around.

“If there’s a clear package in the budget and that’s viewed as credible by the markets and that could be pro-grwoth so there is by all means an opportunty for her [Reeves] to correct where we’ve got to.”