Budget 2025: Make me chaste, but not yet

Overview

Financial markets reacted calmly to the Budget. Despite this, there was enough in the Budget to keep investors on guard about what lies ahead for the UK. 

The fiscal numbers remain worrying. Public spending, taxes, borrowing and debt all remain high.

The Chancellor opted to increase taxes significantly, both to boost her headroom and to fund higher public spending. 

The spending increases are front-loaded, hitting in the next three years, while taxes will rise further later in the decade, projected to reach an all-time high of 38.3% of GDP by 2030/31. Traditionally the UK tax-take has been stable, but lower. But now, in the legacy of the pandemic, both public spending and taxes are about five percent of GDP higher than pre-pandemic.

The Budget allows for a dramatic fall in borrowing in the last years of the five-year forecast. In all likelihood, this will not materialise, with pre-election spending likely to rise more than is planned.

There is something odd about the budgetary process in that the margin of error on just one-year ahead forecasts is high, yet the Budget arithmetic is based on forecasts for public spending, taxation and borrowing for 2029/30, as that’s the year to which the fiscal rules apply.

Calm market reaction

The initial calm reaction of the markets owed itself to two main factors. One, despite all the rumours and speculation in the run-up to the Budget, the fiscal gap turned out to be far smaller than was initially feared. This was largely because high inflation had boosted tax revenues in recent years. Thus, before she made any policy decisions the Chancellor knew she would meet her headroom by £4 billion as higher spending of £22 billion by 2029/30 was offset by increased revenues of £16 billion.

Two, the Chancellor increased her fiscal headroom from £9.9 billion to £21.7 billion. This is the buffer to allow her to meet her main fiscal rule. Increasing the headroom has reduced the possibility of Groundhog Day next year. The Office for Budget Responsibility (OBR) says there is a 59% future possibility of now meeting her self-imposed fiscal rules. Next year, also, will see a move to one fiscal event from two and this should dampen market speculation around meeting the rules.

In addition, markets were helped by news that gilt issuance in 2025/26 is set to increase by £4.6 billion, which was less than the rise of £8.6 billion expected. Nonetheless, gilt issuance will still be sizeable, at £303.7 billion, focussed on short and medium dated gilts.

Also, there is a high likelihood that, following this Budget, the Bank of England will cut the bank rate by 0.25% in December, from 4% to 3.75%, having voted narrowly to leave rates on hold at their last meeting. The OBR has raised its inflation forecast by 0.5% for next year, although the trend is still down. Sticky inflation may yet dampen the scope for rate cuts. However, it is quite possible that the combination of only modest UK growth and intense international competition sees inflation subside more than forecast and interest rates fall significantly next year.

Poor fiscal numbers

Contrary to expectations, the Budget will provide a fiscal stimulus in the next three years of: £4.1 billion (2025/26), £9.3 billion (2026/27) and £7.1 billion (2027/28). 

Then, from 2028/29 onwards, the contractionary impact of the Budget measures will hit, as higher taxes bite. Taxes are expected to fall by £1.9 billion in 2026/27 and then rise by £2.9 billion (2027/28), £10.7 billion (2028/29), £23.2 billion (2029/30) and £26.6 billion in 2030/31. This includes the further freezing of income tax allowances for three years.

This stealth tax was put in place under the Conservatives, dragging more people into higher tax brackets through fiscal drag. By 2030/31 the overall impact of freezing allowances will have been £67 billion, of which £13 billion is due to the freeze announced in this Budget. Other notable taxes included charging national insurance on salary-sacrificed salary contributions (raising £4.7 billion) and higher taxes of 2% on dividends, property and savings incomes (raising £2.1 billion).

The Treasury has always argued in favour of taxes where there is a clearly identified income stream, making them easier to collect and harder to avoid. The danger is that today we now start to deviate from this, as reflected in the mansion tax. Given that this tax starts at £2 million it may be better referred to as a London and the south-east homes tax. The UK taxes housing more than other than country but does it badly, with high stamp duty that deters turnover. Stamp duty remains high, and now there is also a disincentive to renovate or improve properties. A significant number of tradesmen work on upgrading properties, so such taxes could hit a wider group of people than advocates expect.

The OBR noted that to stabilise debt, the government needs to run a primary surplus (which excludes interest payments) of £47 billion per year on average over the next five years. Instead, it currently has a primary deficit this fiscal year of £46 billion. As the OBR stated this is, “£100 billion away from its debt-stabilising level”. Debt will remain high.

Modest growth 

The OBR cut its projections of growth in productivity from 1.3% to 1%, but this is still higher than most other forecasters and double the 0.5% annual average growth in productivity that the UK has seen since the 2008 global financial crisis. 

While the OBR raised its economic growth forecast to 1.5% for 2025, it is then expected to remain around this for the rest of the decade, which is slightly lower than they previously thought. This forecast of modest growth may still prove optimistic. Interestingly the OBR did not view any of the policy measures announced in the Budget as being likely to add to growth. 

Conclusion 

The Budget confirmed that Britain is a high public spending, high tax and high borrowing economy – and with no appetite ever to reform.

Budgets are driven by a combination of politics, economics and the financial numbers. The Budget ahead of an election is driven by politics. However, the first and second Budgets after an election are usually driven by a desire to get the finances into shape, or to outline an economic vision. Unfortunately, that has not been the case in last year’s or this year’s Budget, both of which have been driven by politics and seen higher public spending. Economic growth is low, with living standards set to stagnate and the fiscal numbers fragile. As Saint Augustine said, ‘Make me chaste, but not yet’. This has often been said of the UK finances and seems particularly appropriate now.

Please note that this article is for informational purposes only and should not be relied upon as financial advice.