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The Macro Brief – The UK’s perfect storm
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From sticky inflation to precarious public finances, Liz Martins, Senior UK Economist, assesses the UK’s financial troubles as the country looks ahead to an Autumn Budget.
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Transcript
Introduction to HSBC Global Viewpoint
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
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Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
The Macrobrief Podcast Overview
00:00:24
Speaker
You're listening to The Macrobrief, the podcast that looks at the issues driving financial markets across the globe. This episode was recorded for publication on the 4th of September 2025 by HSBC Global Investment Research.
00:00:35
Speaker
All the disclosures and disclaimers associated with it must be viewed on the link attached to your media player. And remember to like and subscribe to The Macrobrief wherever you get your podcasts.
UK Economy Challenges Discussion
00:00:54
Speaker
Hello, I'm Piers Butler and welcome to the Macrobrief. I'm here in our London studio and this week our focus is very much on the UK, where the economy remains firmly under pressure. Inflation is sticky, gilt yields have been heading higher and the public finances are in a precarious state.
00:01:12
Speaker
Tackling these issues is an unenviable job for Chancellor Rachel Reeves. So with the autumn budget fast approaching, we're looking at what options she has available. And to do that, I'm joined in the studio by Liz Martins, senior UK economist.
00:01:25
Speaker
Liz, great to have you back. Hi, Pez. Not necessarily going to be an easy conversation because it's, ah I mean, as we're recording this, it's been another turbulent week ah for global markets and the UK is very much in focus. I saw this headline earlier in the week that UK 30-year bond yields had risen to the highest level since 1998.
00:01:45
Speaker
So I guess the market continues to be concerned about the UK's fiscal position or, to put it at an even simpler level, the level of government debt. So what's precipitated the market's concern? Is it just that everybody's back from the summer and reminded of the fact that government finances in the UK are not in a great state?
00:02:01
Speaker
yeah I think it's partly that. I mean, actually, these are globally driven moves. So we do see bond yields up around the world. But of course, the market always focuses in on the UK.
Factors Affecting UK's Economy
00:02:10
Speaker
I think there's a number of reasons for that.
00:02:12
Speaker
um One is actually just the memory of what happened in 2022 and the the guilt crisis around the mini budget. That's one of them. um i think the UK has a particular inflation problem at the moment, which means that, you know, a lot of expectations that interest rates aren't going to come down as quickly as maybe had been ah thought a couple of months ago.
00:02:31
Speaker
um You've got the fiscal issue, which we're we're going to talk much more about, but essentially concerns about what's going to happen in the budget in the autumn. um And then the final one for the gilt market is simply that, you know, one of the traditional buyers of gilts, the pension fund industry, is buying a lot less than it used to. so there's a less stable kind of investor base. So, I mean, look, the market is still functioning well, right? We've had an oversubscribed issue, um you know, this week. So yeah I don't want to be over alarmist, but, you know, guilts are rising and and that causes problems.
Fiscal Discipline and Borrowing Limits
00:03:03
Speaker
So is the crux of the problem that the government's room for manoeuvre is very restricted? Why is that? And can they not just borrow more or and or raise taxes? Well, look, I mean, because the market is nervy and and is demanding this kind of high risk premium on gilt yields, um what they are asking government to do is show the market that it has a plan for keeping the public keeping borrowing under control, that it's not just going to rise and rise and rise.
00:03:30
Speaker
um and And the way the government expresses that plan is saying, well, look, we're going to meet these fiscal rules and we'll do it with this much headroom. As you say, the problem here is there's very, very little of that headroom. So in March, when Rachel Reeves last updated us, she left a tiny sliver of just £10 billion pounds against the target. Sounds like a lot of money. it can blow away with the wind very quickly. And indeed, it looks like it has and then some.
Tax Challenges and Budget Scenarios
00:03:57
Speaker
So can you just borrow more? Well, you can try, but the market is going to penalise you for that through higher yields. And of course, people are nervous, not just of of higher yields, but of, you know, something a bit more disorderly, like what happened in 2022.
00:04:12
Speaker
And then why can't we just raise tax? Well, ah you know, mean, first of all, taxes are already forecast to to rise to the highest level as a percent of GDP since the Second World War.
00:04:22
Speaker
um There's a lot of negative noise feeling around that. Of course, companies felt the um the hit of the the national insurance rise from last autumn budget. And, you know, we still hear about that a lot from our corporate clients. It's still a big, big deal for them.
00:04:37
Speaker
But then the other problem with it is that actually the government has promised not to raise taxes, which make up 75% of the revenue base. Which are? just Right, so that would be income tax, VAT, national insurance and corporation tax. Those are the ones that the government has said, we will not increase the rates on these.
00:04:55
Speaker
um Now they can do things like, for example, freeze the income tax threshold, which Rishi Sunak did before them, and you know maybe that will end up happening, and maybe people will say, well, that is an income tax rise, really.
00:05:07
Speaker
um But it's very hard to actually just go out and say, do you know what, we're putting a penny on income tax. um And when you are not raising those taxes, it just makes it really hard um to raise any kind of meaningful amounts of money. So it'ss it's really tough. and And that's why the market's worried, because they're wondering, how is she going to make these numbers add up?
00:05:26
Speaker
And indeed, there's a bit of a deadline here because there's an autumn budget. yeah And what what are we saying that, you know, what room for manoeuvre does she have to do anything within that budget? It will really depend on the numbers that the Office of Budget Responsibility present her with. And I think we'll we'll do some more calculations on that when we get a bit closer. um There are a few things taken into consideration. One is the government tried to cut spending in the spring budget. Well, they tried to cut the winter fuel allowance, of course. They tried to cut disability benefit. Those things...
00:05:55
Speaker
um have had to be reversed due to political pressures. So that's headroom that we did have that's gone. Then you've got the cost of higher guilt yields because as guilt yields rise, we're paying more interest on the national debt. So that um also subtracts from the headroom.
00:06:10
Speaker
And then the third one, the big unknown that could be a huge story, is what the Office of Budget Responsibility decides to do around its productivity forecast because the OBR is a ah productivity bull, actually. They think the productivity is going to pick up in the UK and that will bring revenues and that will you know provide some of this headroom. Now, if they revise that away in autumn, um then she's got a really big problem. So what can she do Depends on the size of the the problem.
00:06:35
Speaker
If it's a small problem, she can tweak it, you know, with things um like, I don't know, there's suggestions on gambling tax. There's, you know, that that frozen threshold. There's but there's lots of things going around in in the press.
00:06:47
Speaker
If it is a big, you know, tens of billions of pounds, it may be that some of those manifesto promises can't be kept. So you wrote about this in a note, in fact, that you co-wrote with our head of UK rate strategy, Danny Russell, summarizing into four scenarios.
00:07:03
Speaker
How do they play out? Are they all very bearish or this there's some good news here? I'm afraid none of them are very pretty. um Look, the and probably the best case scenario is that the OBR is, ah the forecasts are favorable. So they don't revise down productivity. They keep the faith.
00:07:19
Speaker
There is a relatively small and black hole against the targets and she's able to kind of stick a few plasters on it and and muddle through. That does still leave us you know in a precarious position because six months down the line we could be here again but we'll have got through that um hurdle.
00:07:34
Speaker
Our second scenario is that they present her with a much bigger black hole but she deals with it really realistically so really rip the plaster off big tax rises, but at least leave the UK in a healthier position, more headroom at the end. Which the markets, I guess, would like. I think the markets would like that. I mean, there's always the risk that, you know the risk of implementation. Can it actually happen?
00:07:56
Speaker
The risk of slower growth? You know, there will be worries. But yeah, I think on balance, the market wants to see that headroom restored. The third scenario is kind of similar. There's a big black hole. She raises taxes, but it's all got a feel of fiscal fictions. You know, we'll borrow more in the next two years and then in the target year, we'll have this big, you know, consolidation, frozen spending, more tax rises. We'll sort it all out in the target year.
00:08:21
Speaker
And the risk with that is is that the market just doesn't believe it. It's fiscal fiction. And then the fourth scenario, and I have to stress that newspaper reports suggest she won't do this. All the newspaper reports suggest she is sticking to the rules.
00:08:33
Speaker
But the worst scenario, I think, from a market perspective is she doesn't stick with those rules. She says, I can't make these numbers add up. We're going to have to change the rules. And that's the one I think the market would be really unnerved by. Because I suppose it would sort of lose the discipline that at least is still
AI's Impact on UK Productivity
00:08:47
Speaker
there. Yeah, exactly.
00:08:48
Speaker
um In an earlier report, you looked at the 60 key charts for the UK where you highlighted that our labour productivity continues to be weak. It has been a sort of persistent problem in the UK.
00:09:01
Speaker
So if we're trying to look at some positives, could AI start to make a difference? ah It seems to be starting to happen in the US. I asked this question because I read the note by our emerging market and global equity strategist, Alastair Pinder.
00:09:16
Speaker
He wrote highlighting that AI could potentially reduce S&P 500 operating costs by around 1% in the next couple of years. Can we see some of that good news come into the UK?
00:09:28
Speaker
Yeah, I mean, look, we've been looking for productivity for a long time. We've been disappointed um on multiple occasions, but AI does feel like something really different coming along, doesn't it And I have to say, when we talk to our corporate clients, we hear more and more of how they're using it, for example, in marketing and in sales and, and you know, AI doing the work that, you know, would previously have taken ah a week and in in a matter of, you know, minutes. So clearly there are some productivity gains here.
00:09:53
Speaker
um And of course, productivity is the holy grail. It's the thing that would hopefully, in theory, reduce inflation and and generate growth and sort out some of that problem in the public finances. So um we certainly ah live in hope and and continue to to to look at that and monitor it closely.
Monetary Conditions and SME Growth
00:10:09
Speaker
You also highlighted in that report that monetary conditions were looser and starting to boost business loan growth. mean, how significant is that? Look, it's nascent. I think, you know, bank rate has come down from 5.25% to 4% is the point that I was making. I know people are starting to think maybe it won't come down much more than that and the market pricing has moved in that direction.
00:10:30
Speaker
But we have seen a significant loosening. Now, it hasn't done much for gilt yields, but it's brought mortgage rates down and its and we're starting to see, for the first time in four years, SME loan growth in positive territory.
00:10:43
Speaker
um So we'll keep an eye on it. But again, it is a positive sign. And it's not the only yet positive sign, actually. We've had a few more recent positives. i think services PMI was up um quite decent reading. Mortgage approvals were up in in July.
00:10:57
Speaker
um And consumer confidence a tiny bit up. So nothing spectacular, but just some slightly better bits of news out there.
Bank of England's Monetary Policy Approach
00:11:05
Speaker
So maybe just to recap, we come back from the summer. There's obviously some concerns in in terms of treasuries and treasury yields going up.
00:11:13
Speaker
But as you said, and I think it's worth reminding at the start of this conversation, the market cleared this week. It's not like we're sort of facing some kind of crisis and what have you. There are obviously concerns, but there is a budget coming through.
00:11:25
Speaker
And also, what what is the Bank of England likely to do in its next meeting? Yeah, so the Bank of England, of course, um you know, very cautious tone in its last communications. So it cut rates in August, but only by the narrowest of margins, five votes for a cut, four for a hold.
00:11:41
Speaker
um And the message was, look, do you know what? Inflation is too high. We're not sure. um You know, we think the rate of rate of travel is the direction of travel is still downwards, but we're not sure, you know, how much further or how fast to to continue easing. So, um you know, the BOE is looking for evidence of continued disinflation um and maybe, you know, with a slightly higher bar for cutting rates than than has been the case of late The other decision they've got to make is around quantitative tightening um and they will announce that in September. Sorry, what does that mean? Right. So the Bank of England is reducing its portfolio of all the bonds it bought through the various QE programmes. Which you bought a lot. Yeah, it was a lot. Yeah, exactly. And it's made good progress in reducing it. um And part of that is actively selling bonds into the market.
00:12:26
Speaker
um So it will tell us how much it's going to be selling in the in the September meeting. And our view is that, um look, they might or might not um reduce the pace of sales. But what we do think they'll do is um skew the sales such that they are um selling less at the long end, which is where the most acute pressures are in in the UK market, um and and more towards selling towards a short end.
00:12:51
Speaker
um And that could help the gilt market a little bit, just relieve a little bit of the pressure that at a time when, you know, long-end yields are under pressure, actually you don't want the Bank of England selling into that. So, you know, maybe maybe that will will help a little bit. And if we get through the budget and it's, um you know, it's it's it's it's not too bad, then hopefully the the environment will be a little bit better thereafter. When is the Bank of England meeting?
00:13:13
Speaker
It's the 18th of September.
Digital Finance and Cryptocurrency
00:13:15
Speaker
Well, I'm sure we'll be having you after that. But in the meantime, good luck keeping track of it all. And thank you for joining us today. Thanks, Fiers.
00:13:25
Speaker
We're getting close to the next edition of our live insights on LinkedIn. Please join me on the 10th of September, where I'll be talking to Dara Mar, head of digital assets research on the fast-growing world of digital finance.
00:13:37
Speaker
It's a great opportunity to put your questions to Dara. So if you want to know more about cryptocurrencies, stablecoins, or blockchain, then please join us next Wednesday.
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00:14:14
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So that's all from us this week. Please join us again soon for more insights and views on the macro roof.
00:14:42
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