In response to the recent Labour Budget, abrdn’s experts analyse the implications for bond markets and macroeconomic conditions. They highlight key fiscal changes, including new stability rules, significant tax increases, and increased spending, shedding light on the challenges and opportunities for investors in the current landscape.
Bond markets
Matthew Amis, Investment Director, says: “Large but not reckless would be the best way to describe the Chancellor’s Budget increases, which spanned spending, taxation and borrowing. At abrdn, we believe gilt prices can rise relative to peers, however they will struggle to fully unwind the ‘Budget premium’ built up over recent weeks – which saw UK government bond prices fall over fears of increased spending.
Rachel Reeves has given the market some level of reassurance, with the tighter than expected stability rule and the increased tax haul. Even so, for her to balance the current budget in three years seems a hard task.
Longer-term, the gilt market will struggle to look past the large increases in borrowing announced today. Investors will need to absorb an extra £142 billion of issuance over the next five years. The extra long gilt issuance is catching the market off-guard.”
Macro
Chief Economist Paul Diggle gives his four key takeaways from the Budget:
“First, we got new fiscal rules.
The “stability rule” requires the current budget to be in balance (ie taxes fund day-to-day spending) within a three-year horizon, starting in 2029/30. That’s a stricter rule than the previous government used.
The “investment rule” requires public debt as a share of GDP to be falling within three years, starting in 2029/30. Importantly, the definition of public debt is now “public sector net financial liabilities”, which takes account of some of the benefits of public investment as well as the costs. So it’s a more permissive rule than the previous government used.
Second, we got higher than expected tax increases.
There were more than £40bn of tax rises in this Budget, making it the biggest tax rising Budget in 30 years. UK tax take as a share of GDP is going to rise from 36.4% now to a historic high of 38.2% in 2029-30.
The biggest tax measure (raising £25bn) was a 1.2% increase in employer national insurance contributions, to 15%, alongside the threshold for paying this tax falling from £9,000 to £5,000 of earnings. Alongside a higher minimum wage, this means business is carry the burden in this Budget – although the ultimate tax incidence is likely to be workers.
There were also changes to capital gains tax and inheritance tax, among others.
But fuel duty has been frozen again, while the “fiscal drag” that comes from freezing income tax thresholds is apparently ending in 2028/29. These are the closest things this Budget had to a “rabbit out of the hat” announcement.
Third, day-to-day spending is increasing, by 1.5% in real terms.
While that was enough for the Chancellor to declare “no return to austerity”, it’s a pretty small spending increase once protected departments like the NHS and defence are taken into account. Many UK public services will still feel squeezed.
There were also some big one-off costs in this Budget to compensate the victims of the infected blood and Post Office-Horizon scandals.
Fourth, investment spending is increasing significantly – by a cumulative £100bn over five years.
This is being spent on things like capitalising the National Wealth Fund, R&D spending, homebuilding programmes, rail electrification upgrades, and aerospace, automative, and life science funding.
The Chancellor hopes this will improve the UK’s trend growth rate – although the Office for Budget Responsibility rather scathingly says that “taken together, Budget policies leave the level of output broadly unchanged at the forecast horizon” even if it holds out the possibility that “in the longer term, the net effect of Budget policies would be positive for the economy-wide capital stock and potential output if the increase in public investment were to be sustained”.
All told, this is a higher tax and higher spending Budget. The market reaction has been somewhat volatile, with gilts initially rally but now selling off as investors digest the borrowing increase to come. While the investment spending increases introduce upside risks around long-term UK growth, the burden is still on the government to deliver on its growth agenda while keeping markets onside.”
