Key Highlights
- The Labour government faces a significant fiscal shortfall in the upcoming budget.
- The Autumn Statement, to be presented on 26 November, will include independent forecasts from the Office of Budget Responsibility (OBR).
- A potential tax rise and spending cuts are expected to address the fiscal gap.
- The GBP is projected to remain negative due to unsustainable public finances and a USD-negative environment.
UK Economy at Crossroads: Autumn Statement Brings Fiscal Challenges
Danske Research Team, from Danske Bank A/S, has issued a detailed analysis of the upcoming Autumn Statement, which is scheduled to be presented on 26 November. The statement will mark a critical juncture for UK markets and the economy as the Labour government grapples with significant fiscal challenges.
The government faces a substantial fiscal hole, exacerbated by an expected 0.3 percentage point reduction in trend productivity growth, according to independent forecasts from the Office of Budget Responsibility (OBR). This adjustment, larger than anticipated at 0.1-0.2 percentage points, adds approximately GBP12 billion to the overall shortfall, bringing it to a total of GBP30-40 billion.
Fiscal Tightening and Revenue Concerns
Chancellor Rachel Reeves is expected to implement some fiscal tightening measures in response to these challenges. The government aims to address the shortfall without immediately increasing income tax rates, National Insurance contributions, or VAT—three main sources of revenue. However, this leaves open the possibility of raising taxes and cutting spending as potential solutions.
Reeves has attributed much of the fiscal and economic troubles to Brexit and the previous Conservative government’s policies. According to Danske Research Team, the Labour government may aim to resolve these issues now, given that a general election is still some time away, to avoid future tax hikes.
Impact on Gilt Markets and GBP FX
The Autumn Statement will be pivotal for both the gilt market and the pound sterling (GBP). The research team suggests that while a significant tightening of fiscal policy could alleviate some pressure from unsustainable public finances, it may also have negative growth implications. This could lead to further easing by the Bank of England (BoE) and contribute to a weaker GBP.
The report notes that a 1 percentage point increase in the basic rate of income tax would yield approximately GBP8 billion, according to UK tax authorities, while a VAT hike, though potentially boosting revenue, could trigger higher inflation and short-term upward pressure on UK yields.
These measures are crucial as they balance the need for fiscal stability with economic growth.
Danske Research Team remains negative on GBP FX, predicting that EUR/GBP may trend towards 0.89 in a year’s time due to the combined factors of significant tightening and a USD-negative environment. This outlook underscores the complex interplay between fiscal policy and market dynamics in shaping economic outcomes.
Conclusion
Navigating Fiscal Challenges
The upcoming Autumn Statement presents both opportunities and challenges for the UK economy. As the Labour government seeks to address its fiscal gap, it must carefully navigate the delicate balance of tightening policies while avoiding overly negative impacts on growth. The market’s response will be keenly watched, with potential repercussions for not only the UK but also global markets.
For investors and policymakers alike, this statement serves as a critical test of the government’s ability to implement effective fiscal measures without derailing economic progress. The coming months will provide valuable insights into how these challenges are being managed and their broader implications for the UK economy.
