Bond Watch: short- and long-term impact of Autumn Budget

One week on from the UK’s Autumn Budget and bond markets have had time to digest the implications of Chancellor Rachel Reeves’ announcements. In all, the market reaction, following some volatility on the day, has been sanguine.

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How did markets react?

The pound strengthened while gilt yields broadly fell across maturities. The downward trajectory of short-term gilt yields has not been halted and, on balance, there were not too many near-term inflationary surprises - minimum wage increases will take effect next April and were largely expected. Expectations of a December rate cut remain.

Meanwhile, the revelation of increased fiscal headroom, implying a fall in future issuance of government bonds and a more stable fiscal position, saw rate-sensitive, long-term gilt prices react positively. The relief rally in gilts has been welcome, but it’s likely too soon to relax.

Did chancellor present credible fiscal consolidation?

With self-imposed fiscal rules, a lack of progress in welfare spending reform and near full employment quelling any chance of a cyclical uplift in tax take, the market was poised for tax hikes. Seemingly, prior to the Budget, the market would have accepted a breach of Labour’s pledge to not directly “increase tax on working people”.

However, the £26 billion tax revenue increase spread across the coming five years that we got instead via manifesto-compliant (at least semantically) measures – e.g. freezing tax thresholds, increased national insurance contributions (NIC) on salary sacrifice and a range of asset taxes/duties – could superficially achieve a similar revenue-raising effect.

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For the other component of the Budget balancing equation – expenditure – there’s little progress to celebrate though. Efficiency and savings targets are in play, but government expenditure across most departments will continue to rise. So, the UK individual and corporation will shoulder the tax burden of closing the gap between government outgoings and incomings. HMRC’s tax take, according to the Office for Budget Responsibility (OBR), will reach an all-time high of 38% of GDP by 2029-30.

What can we expect in the longer term?

From the perspective of the creditors of the UK government – a group that a fair number of interactive investor’s customers will form part of - the Autumn Budget has offered a degree of reassurance in the chancellor’s fiscal credibility. Having now traversed a major risk event, we might take some reassurance in the steps taken towards stabilising fiscal policy, even as we face the practical challenge of anticipating the effects of staggered and complex policy changes.

One concerning factor though is the backloaded nature of tax adjustments, which means much of the fiscal consolidation will not take effect immediately, so government net borrowing is anticipated to remain elevated in the near term. Problematic is the fact that, while a clear-cut increase in income tax might have allowed easy forecasting of future tax revenues, the hodgepodge of threshold freezes or changes and duties to be introduced is harder to forecast with certainty.

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Further, the Organisation for Economic Co-operation and Development (OECD)’s most recent outlook will align with the fears of many investors, citing the negative implications of tax adjustments anticipated for household income and consumption in future.

For gilt investors positioned at the longer end of the curve, any failure of expected tax revenues to materialise or renewed disruption to the growth outlook could translate into greater yield volatility and a resurgence in term premia - meaning investors may demand progressively more compensation for holding long-dated bonds should perceived long-run fiscal and economic risks rise.