After the spending review, focus turns now to the autumn Budget

I appeared on the Telegraph’s Planet Normal podcast immediately after the Spending Review. Here are some of the key takeaways from the Review.

On Wednesday the Chancellor delivered the first comprehensive or multi-year Spending Review since 2021, as she outlined spending plans by government departments for the coming years. There were two main areas of focus: the breakdown of day-to-day spending plans for three years and of capital budgets for four years. 

There were no tax or borrowing announcements in the Review. Those will have to wait until the autumn Budget. On existing plans, further tax and borrowing over and above what has already been unveiled is not expected, but as we all know, plans can change. The big issue for the economy and markets was to decide whether the spending plans were credible and what this might mean for the Budget later this year.

The Chancellor was in a difficult position ahead of this Review. The political pressure to increase spending is intense and the partial U-turn announced a few days ahead of the Review highlighted the pressure the Chancellor is under. Yet the fiscal room for manoeuvre is limited, as the debt level is high and as we saw in the spring statement, the fiscal rules provide little room for manoeuvre, the growth outlook is modest and borrowing costs have been under recent upward pressure.

The previous government had outlined a 0.7% pa rise in departmental spending for 2023/24 to 2028/29 and this was increased to 1.7% pa by this government in last autumn’s Budget, with the increase being front-loaded. As a result, we knew ahead of this Review that the spending envelope was for a 1.2% pa rise in day-to-day spend over the next three fiscal years. Meanwhile, the spending envelope for capital spending was a 1.3% pa rise over four years.

As expected, the Review confirmed that health spending would rise significantly on a day-to-day basis – a level that would put pressure on many other departmental budgets. If we look at the three years, 2025/26 to 2028/29 to reflect the new plans just unveiled, health spending is due to rise by 2.7% pa and defence by 3.8% pa. These are average annual increases. 

Because of their scale, many other departments will see a less-than-average increase or may face actual cuts. For instance, the Foreign Office faces cuts of 8.3% pa, the Home Office is down 1.4% pa and Education is up 0.8% pa, all in real time over the three-year period. 

What were the positives? There was a welcome increase in public investment. This was also a welcome feature of last year’s Budget, although that was overshadowed by the increase in borrowing and, in particular, by the rise in taxes then announced, with higher national insurance – a tax on jobs – now weighing on employment. The UK has suffered from a low rate of investment for decades, in both the public and private sector. The benefits of a rise in public investment will take time to feed through.

Other positive aspects of the Review included more of the overall spending impacts from higher capital spending to be seen locally, including by small and medium-sized enterprises, with munitions being cited by the Chancellor as an example. She also announced spending to help boost nuclear power – part of a welcome and necessary diversification of the energy mix. 

The immediate worry from an economic perspective is that we are heading for a repeat of last year when there was a fear that the government’s first Budget would be tough. Talk of a black hole and the talking down of the economy then meant that ahead of last year’s autumn Budget, confidence took a big hit. Now, the Chancellor is more likely to be upbeat but the focus nonetheless among the markets and economists is that this year’s Budget may have to deliver higher taxes and increased borrowing to fund spending plans. 

If current economic and fiscal numbers unveiled in the March spring forecast turn out to be in line, or better than expected, then taxes will not need to rise, and borrowing will remain in line with expectations. But the likelihood is that this will not be the case. What happens in this year’s autumn Budget will depend upon the trend in the debt numbers, market interest rates and the updated economic and fiscal forecasts unveiled by the Office for Budget Responsibility (OBR) at Budget time. Also, any U-turns on existing spending plans add to the pressure. 

In terms of controlling the controllables, the government will need to demonstrate that they can keep spending under control and they will need to ensure, or retain, the confidence of the markets that their economic policy will boost growth and that their fiscal plans will be met.

The latest UK GDP figures, delivered the day after the Review, showed a 0.3% month-on-month fall in GDP in April, reflecting a large fall in service sector output. The monthly GDP figures can be volatile, and the three-month trend to April shows a steady rise of 0.7% compared with the previous three months. 

Although the main positive for the economy is that real incomes are rising, which should help spending, there are two wider, and bigger worries. One is that the impact of the tax hikes announced in last year’s Budget are now feeding through, with higher national insurance, and it is noticeable that the recent jobs trend has softened significantly, with a fall in April. 

The second concern is the international context and the impact of higher US tariffs, which not only hit exports to the US in April but may weigh on overall business confidence. There is also uncertainty about the inflation outlook over the summer, which may weigh on the timing and likely scale of rate cuts by the Bank of England.

Naturally, the Chancellor’s target audiences were the general public and the political arena but the other key group is the bond and financial markets. They remain concerned about the direction of travel on UK debt. The economic and financial backdrop is not helpful for the Chancellor's plans to be seen as credible. Growth is modest, but the economy may lose some momentum, and while policy rates can fall, they are expected to settle at a higher level than previously. 

Bond yields are high and rising. This is keeping the yield curve steep, and the level of yields will not help debt service figures. The focus therefore returns to traditional factors: tax, spend and borrowing numbers, and how they interact. 

If these spending plans are not seen as credible then the markets will focus on this autumn’s Budget delivering higher taxes or more borrowing. The danger is that, as last year, this may dent confidence ahead of the Budget, at a time when the tax increases announced last autumn – which saw a tax on jobs through higher national insurance – have contributed to a softer labour market, with jobs being shed. 

Higher taxes are not inevitable in the autumn, but are likely, and borrowing will remain high.

Please note, the value of your investments can go down as well as up.