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The Macro Brief – The UK's budget tightrope
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Liz Martins, Senior UK Economist, and Nick Andrews, Senior FX Strategist, talk through the key takeaways from the UK's highly anticipated budget.
Click here for appropriate Disclosures, including analyst certifications, and Disclaimers that must be viewed with this podcast: https://www.research.hsbc.com/R/101/c6DrlPx
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Transcript
Podcast Introduction
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
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
UK Budget Announcement
00:00:33
Speaker
Hello, I'm P.S. Butler in London and welcome to the Macrobrief from HSBC Global Investment Research, the podcast that looks at the issues driving financial markets across the globe. And after weeks of market and press speculation, Chancellor Rachel Reeves has finally delivered the UK's budget.
00:00:49
Speaker
So with the pressure on, what reception did it receive? And what could it mean for the UK's outlook heading into 2026? To help give us a clearer picture, I'm joined in the studio by Liz Martins, Senior UK Economist, and Nick Andrews, Senior FX Strategist. Liz and Nick, welcome to the podcast.
00:01:07
Speaker
Thank you. It's obviously been in a busy time for you. But Liz, I'm conscious that our listeners will probably have already seen many headlines about the budget already. I guess if one takes our cues from the markets, it was better received than one could have expected?
00:01:20
Speaker
little bit, yeah. I think you have to put it in the context of the ways this could have gone. And we kept saying this could get really messy. If Rachel Reeves had not done enough tightening for the market's liking and it looked like you know we weren't going to maybe meet some of those fiscal targets, if she had done too much tightening and it looked like the Labour MPs weren't going to approve the budget in Parliament, either one of those situations could have really led to some really unsettled market moves.
00:01:46
Speaker
In the end, you know we set out three boxes she needed to tick. It needed to be acceptable to both the bond market and the parliamentary Labour Party. It needed to be broadly disinflationary. It needed to build in a bit more headroom.
Market Reactions and Sterling Response
00:01:58
Speaker
And she's ticked all those boxes. So yeah, on the day, it was it was good. It was good news.
00:02:03
Speaker
And is that partly because it was quite well flagged in the end? Well, yeah, I don't think anyone can have been surprised by very much in the ah in the budget. You know, I think a lot of the policies have obviously been trailed in the press. We knew there was a big black hole. We knew taxes were going have to go up as a result of it. um And we knew quite a lot of the detail of those tax rises. So much as nobody likes to see, you know, billions of pounds of of tax rises, much as people will be disappointed that there wasn't perhaps more on on the growth side, um nobody can really claim to have been very surprised by what was here.
00:02:37
Speaker
And Nick, for sterling, was that a similar state of play? Yeah, it was. um If you think back to, say, July, this is when the market really started to worry about the budget. You had the OBR first flag their worries about productivity growth. And so from then, the market started to price in you know some dangers around this budget.
00:02:57
Speaker
The market started to add short positions on sterling, and they continued to build up basically up until the day. And because a lot of the news, the bad news or the measures were trailed as well before in the press beforehand, what actually occurred, what was released wasn't as bad as people expected. So it's a bit of a relief in some ways. And you've seen that in sterling. There wasn't too much a wobble on the day. And actually, sterling's rallied a little bit since. That's right. So sterling has strengthened relative to the dollar. yeah Ten year bond yields have come down a bit. They came down, they reversed some of their gains, but they're pretty, they're happy. they're not they're on the And the FTSE is up slightly. So, as you say, not not a bad result, all told.
00:03:36
Speaker
let's Let's sort of dig down a little bit. The key, it seems, in achieving this kind of mildly positive result was delivering this so-called fiscal headroom.
Budget Goals and Fiscal Strategy
00:03:45
Speaker
So, am I right in saying that the government aims for a balanced budget, ah but markets like to see some margin in case things don't go according to plan, and that margin has improved? That's exactly right. So the fiscal target is that we have a balanced current budget in 2029-30 and that budget is now forecast to be in surplus to the tune of £22 billion. pounds Previously, um it was just £10 billion. pounds So she's more than doubled that margin for error. And that means if things get worse, if growth's a bit weaker than the OBR is penciled in, if unemployment's a bit higher, maybe guilt yields a bit higher as well, um borrowing forecasts can be revised up, but hopefully within that headroom, such that she doesn't have to be tinkering with policy and coming back again and again. And the hope is, you know, we've had a bit of uncertainty associated with this budget. The hope is we're not going to go through that now next year.
00:04:37
Speaker
Much has been made of the government's tax take rising to an all-time high. But for me, isn't that somehow inevitable given an aging population? And is it really that high compared to other developed economies who are also suffering from aging populations, particularly in the rest of Europe? I think that's a really ah fair point. If we look around Europe, we see many of the same... fiscal pressures and it is about aging societies. We're all living longer, claiming the state pension for longer. Our needs, our claims on the health service, of course, become more expensive as healthcare care becomes more sophisticated. um And there are other structural issues in the yeah UK around disability and and and and people who are outside of the labour market and claiming incapacity benefits like that. So, you know, I do think unless we are prepared to take some really difficult decisions around the state pension, around the retirement age, around the National Health Service, it is inevitable that taxes are going to go up. And I suspect, you know, whoever had won the election, you know, would have faced kind of similar um decisions to make. They might have taken slightly different decisions, but um you're right, those fiscal pressures really are inevitable. And to your point about the this geographical comparison, yeah, the UK, we are heading towards an all-time high in the tax take. We are not the most highly taxed country out there. That might be scant consolation to people noticing their tax going up year after year, but we're not the most highly taxed, that's true.
Productivity Forecasts and AI Impact
00:05:55
Speaker
Can I also ask, I mean it was widely trailed amongst other budget measures, about the sort of productivity growth forecasts. For me it seems at odds with all that's been said about AI boosting productivity, so how do we square that?
00:06:07
Speaker
Yeah, so basically the OBR for years has been forecasting that productivity will turn a corner and pick back up and and go back to what it used to be. And and and year after year, budget after budget, it's disappointed and it has to revise that um down. So this time round it said, look, do you know what, we're going to give up on that structure. Well, not give up completely, um but certainly lower our expectations that that productivity increases. reversal will will come through. Now let's hope that's a contrarian indicator and as you say we have a lot of technology and AI offering some some brighter prospects for productivity. So let's hope that the OBR finally giving up on productivity is the turning point.
00:06:47
Speaker
So now that ah we're through this long-awaited budget, what's next? i mean, Christmas is is is only four weeks away, but some of the policies have been seen as bearing down on inflation.
Bank of England and US Federal Reserve Outlook
00:06:57
Speaker
So is the Bank of England going to take note? And and a Bank of England and meeting is due soon, isn't it?
00:07:02
Speaker
Yeah, that's right. So the Bank of England have a meeting on the 18th of December at which the market is pretty convinced they're going to cut interest rates. You know, our own forecast is that they might prefer to wait till the February forecast round, really process every all the news that we got in the budget and all the news that we've had in the data, work out what that means for the inflation forecast and act then.
00:07:22
Speaker
But you know what? The market is is very heavily priced for December. So clearly there's ah there's a good chance we're we're wrong on that front. But the point is, December, February. It's quite soon. Direction of travel on interest rates are down. And if these government policies, you know, one was to um reduce household energy bills, the other was to freeze train fares. They're supposed to reduce inflation by 0.3 to 0.5, depending on the point in in time.
00:07:45
Speaker
um And, um you know, hopefully that contributes to the UK's disinflationary process and allows rates to to come down. Nick? Yeah, I'd like to just pop in there because um in terms of the currency outlook, the the direction of inflation, how much it comes down and how much that impacts the Bank of England is really important. because at the moment the markets didn't really change their pricing after the budget on the outlook for the Bank of England.
00:08:10
Speaker
But if, say, inflation remains sticky, then the Bank of England could remain a little bit higher for longer and that could support sterling for for, you know, for a bit longer as well. Whereas if inflation does go down more than expected, then that would have the opposite effect and weaken sterling. But at the current standpoint, You know, if we compare the outlook for the Bank of England with the outlook for the ECB, it looks like there's going to be some stabilisation with sterling versus the euro, because both of those have a fairly gradual path. In Europe, rates are on hold really for the foreseeable. In the UK, the path is really pretty much priced already most of the way.
00:08:44
Speaker
And if I can stay with you, Nick, is the focus going to switch to the US and the prospect of a Fed rate cut and indeed who is going to be the next chair of the Fed? I think that's the big question now for the next few months. um For so long, the UK market at least has been focused on this big event. You know, they've been pricing in short positions and and risk events. Now, like I said before, it's bit of a relief now that that that the worst hasn't happened. And I think the market's going to start turning their focus onto something else.
00:09:12
Speaker
And given that, like I said, a lot of the stuff is priced into the Bank of England already, the next issue is what does the Fed do? um When does the Fed meet? The Fed is on the 10th of December. Right. So not that long ah away, but we've had the U.S. government shut down, so we've had a lack of data, so there's a fair amount of uncertainty. In the last week or so, some of the comments coming out of the the Fed suggests that they're more likely to cut in December. But what happens after that and the signaling from the Fed, I think is very important for the dollar more broadly um and on the reverse of that sterling. um But also, like you said,
00:09:48
Speaker
The President, President Trump, is due to name a new Fed chair. And given that the favorite at the moment is someone called Kevin Hassett, he's a White House insider, it suggests that maybe he would be more dovish and potentially push down expectations of rate cuts or push down the yield curve is what I mean. Which could which could it in a way be a positive for Sterling? It could be positive because it would weigh on the dollar, yes.
00:10:13
Speaker
If I can finish with you, Liz, we've had all this anticipation around
UK Spring Statement and Future Speculations
00:10:17
Speaker
the UK budget. Are we going to have the same thing in the spring with the spring statement or are we doing away with that? Oh, I do hope not, Piers. I think my reaction comes from a bit of emotional exhaustion after the last few few weeks, to be quite honest. But um no, look, I think Rachel Reeves has always wanted the spring statement to be a non-event. And she kind of alluded to that in her speech earlier. in the budget where she kind of said, we're going to take the IMF's advice, we're just going to do one event a year. The problem is, um the as far as we can see in the detail, not much is really going to change. So the Office of Budget Responsibility is still going to put out a fiscal forecast. That fiscal forecast will still include how much
00:10:57
Speaker
headroom there is against the targets. And if it looks like that headroom has gone away again, then sure enough, the market is going to put pressure on the Chancellor to take more action. So I am sincerely hoping um that we have enough headroom um and that the economy sort of stabilizes from here so that we don't go through that all over again in just a few months time.
00:11:17
Speaker
Well, in in any case, um I hope you do have a break over Christmas off of this activity on the economic front. But for now, thank you very much for joining us. Thank you very much.
00:11:33
Speaker
Liz Martins and Nick Andrews there on the implications of the UK's new budget. If you're an HSBC client, you can keep up to date on our latest research by downloading our mobile app.
00:11:44
Speaker
The app features all our key reports, videos and podcasts and can be downloaded from Apple's App Store or Google Play. While you're there, don't forget to check out our sister podcast, Under the Banyan Tree, where hosts Fred Newman and Harold van der Linde put the region's markets and economics into context.
00:12:02
Speaker
And if you've got any questions or comments, then you can get in touch with us at askresearch at hsbc.com. So that's all we've got time for today.
00:12:12
Speaker
This episode of The Macro Brief was hosted by me, Piers Butler, and produced by Tom Barton. Thanks for listening, and please join us again next week.
00:12:43
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.