United Kingdom: Budget poses risks to fiscal headroom and rates - ING

Higher debt interest costs are expected to reduce fiscal headroom in the UK Autumn Budget, according to ING economist James Smith. He anticipates limited stimulus and modest tax rises to restore room under the fiscal rules. While Smith expects little impact on the Bank of England, unexpected developments in wage growth, spending and tax policy could shift the outlook for UK bond issuance and interest rates.

Fiscal headroom tightens, with spending and issuance in focus

"In short, we don't expect the budget to deliver a material stimulus (or add materially to the already-planned fiscal consolidation). The impact on the Bank of England, which is poised to hike rates in November, is likely to be fairly minimal."

"We think that headroom will have dropped to around £10bn before any corrective action. And the vibe from the Treasury suggests the Chancellor would prefer it to be above £15bn, to give more breathing space in case of future adverse forecast revisions. That would point to some limited tax hikes."

"But even relatively small upgrades to wage growth can make a big difference to the government’s fortunes. Since 2010, the OBR has revised the level of earnings across its five-year forecast by an average of 1.3 percentage points in absolute terms. If it did that now, say by lifting wage growth over the next two years by 0.6ppt apiece, it would add £10bn to headroom, almost perfectly offsetting the hit from higher interest costs."

"Ultimately, the key thing to watch is the OBR’s assessment of how all these policy changes affect GDP growth and borrowing over the next year. If there’s a material stimulus effect, it could add to market bets on UK rate hikes."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Find out more.)