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Chaotic release
 

The UK’s Autumn Budget is out after a chaotic early release – and for investors, the news is not entirely welcome.

Gilt yields initially fell as initial leaked headlines of the Office for Budget Responsibility’s assessment of the Treasury’s plan began to emerge. The level of headroom – the margin for error surrounding the government’s main fiscal rule to balance day-to-day spending with tax revenues by 2029 – has increased to £22bn, from £9bn in the spring.

But beneath the surface, the story is more nuanced.

For all the talk of a significant fiscal hole over recent weeks, the OBR’s economic forecast revisions only shaved £6bn off the government’s headroom. A well-flagged 0.3pp per year cut in the UK’s productivity growth was heavily offset by near-term upgrades to inflation/wage growth. We’d expected the shortfall from economic downgrades to total at least £15bn.

So a smaller fiscal hole, which means the degree of fiscal consolidation required was more modest, too. While tax hikes add up to an additional £26bn/year in revenue by 2029/30 – 0.75% of GDP - virtually none of this will come through in 2026.

That is absolutely key. Investors had already begun to reach that conclusion after the U-turn on hiking income tax a couple of weeks ago; gilt yields rose by 21bp in the immediate few days that followed, before falling back thereafter. A more significant fall in yields today would have required a greater share of the tax hikes to kick in immediately.

Tax threshold freezes – a key plank of this budget – are already frozen until 2028. Extending them into the next decade will raise an additional £8bn, but not immediately. Changes to pension taxation and a levy on high value properties are similarly delayed. For investors, it does beg the question of whether these policies get watered down - particularly with the next election set to coincide with many of these planned tax hikes.

Zooming out a bit though, the UK’s public finances are set to improve next year – and the Autumn Budget doesn’t change that. Public Sector Net Borrowing is forecast to fall from 4.5% this year, to 3.5% next, in large part because of the long-standing freeze in income tax thresholds. Importantly, the government has resisted pressure to increase departmental budgets in 2026 more aggressively, too. Those budgets will increase by 1.8% in real terms next year, considerably less generous than the 3.3/3.4% increases seen through FY2024 and 2025.

Add that all together, and the Debt Management Office has confirmed that it expects issuance to be lower in FY2026.

BoE December rate cut remains likely
 

For the Bank of England, the Autumn Budget doesn’t materially alter the case for further rate cuts. A more material fiscal tightening in 2026 would have argued more convincingly for offsetting monetary easing.

We do still think a December rate cut remains likely, though. Cuts to energy bills will lower headline inflation in 2026, even if not significantly – perhaps by 0.3pp. That’s helpful at a time when the Bank’s hawks are worried that high rates of inflation today could fuel inflation expectations, keeping price pressures elevated well into the future. But recent inflation and wage data has hinted that those concerns are overblown. We expect three more cuts from the BoE, including one in December, and that view hasn’t changed as a result of the Budget.

That leaves the million-pound question: will the Chancellor have to come back for more tax hikes in 2026? Ever since last year’s Budget, we felt tax hikes this year were inevitable. Next year, we’re less sure.

The Chancellor has left herself with a greater buffer after the fiscal rules – rules which will become more helpful for her by the time of the next budget. It’s an underappreciated point, but from 2026, the Treasury’s rules will allow Reeves to run a 0.5% current budget deficit by the end of the forecast horizon. That will add another £17bn to the fiscal headroom. Unless the economic outlook turns sour, that raises the bar for further tax hikes next year.

Yet the UK’s public finances remain precarious. The DMO projects Gilt issuance to remain close to, or even above £300bn for each of the next three years. And given the strain on public services, political pressure to top up day-to-day spending will inevitably grow. Current plans have departmental budgets rising by an average of 0.6% per year in 2027-30.

Adding extra cash may well require a fresh conversation about tax. And with many of the smaller tax levers already pulled in this and the last Autumn Budget, it will get harder to raise more revenue without touching one of the major taxes.

Gilt investors were satisfied today, but fiscal concerns not over
 

The knee-jerk reaction in Gilt yields just after the leaking of the OBR report and also during earlier Budget rumours underline the markets’ sensitivity to the UK’s fiscal outlook. With the 10Y Gilt yield a few basis points lower in the aftermath, investors seem reasonably content with the Chancellor’s efforts to contain the government’s debt.

Part of the nudge lower in Gilt yields may also be due to investors’ positioning going into today, given there was a non-negligible risk that the Budget would fail to show credibility. For now there is some relief, but as mentioned above, we may very well face more uncertainty again in the near future.

At time of writing, Gilt yields are currently off around 4-5bp across the curve from their pre-OBR leak levels and EUR/GBP is off around 0.4%. At above 1.32, GBP/USD is back to levels seen in late October.

Over recent weeks Gilts and sterling have been pushed around by both fiscal credibility issues and by what today’s Budget could mean for BoE policy. While Gilt investors could have shown concern over the back-loaded nature of fiscal consolidation, instead they seemed to have backed Chancellor Reeves and the OBR’s path for narrower budget deficits over the next five years.

We had estimated that there was around a 10bp risk premium priced into Gilts ahead of this Budget, suggesting there could be a little more upside for Gilts from current levels. Helping the story as well has been the DMO’s Gilt issuance plans of £304bn and £275bn for '25/26 and '26/27 respectively, broadly as expected.

As for sterling, there had not been too much risk priced into the pound, but today’s Budget is not particularly contractionary in the short term and has not caused a significant repricing of the BoE terminal rate. This has provided a little support. Remember that it was the prospect of big income tax hikes and what it could mean for the BoE policy in 2026 which had hit sterling a couple of weeks ago.

We doubt sterling needs to rally too much further from here, however. We still look for the BoE to cut rates in December and expect the policy rate to be cut a little more quickly to the 3.25% area than the market currently prices. We expect EUR/GBP to find good support ahead of 0.87 and still favour a move towards 0.90 next year.

Perhaps one of the biggest turnarounds today has been the FTSE 100. This is up close to 1% from intraday lows led by financials. The two potential positives here are the Chancellor going ahead with plans to encourage ISAs to be used for investment purposes from 2027 onwards and the rumoured Stamp Duty Reserve Tax exemptions for UK listings over the next three years. These moves will be welcomed by the City, but a more durable rally in UK equities will surely hang on UK growth prospects – which still look unspectacular.

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