On November 26, the UK government (rated AA, Stable trend) presented its second Autumn Budget against a backdrop of a challenging fiscal environment. The government has limited headroom under its fiscal rule, and recent welfare policy reversals, elevated debt interest costs, and a softer growth outlook have further narrowed fiscal space.
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The UK has run larger fiscal deficits in recent years as compared to historic norms, but the deficit has begun to narrow amid a shift towards tighter fiscal policy. Consistent execution and continued budget discipline will be needed to limit increases in debt metrics and restore increased flexibility to respond to shocks.
As expected, this budget proposes a very gradual fiscal consolidation largely through backloaded revenue-raising measures. The UK government announced an extension of the income tax threshold freeze through FY30-31, a cap on tax-free pension contributions, gambling tax rises, a mileage-based tax on electric cars, and a range of other small tax-raising measures. The government also presented an increase to the national minimum wage and the removal of the two-child benefit cap. The Office for Budget Responsibility (OBR) forecasts the deficit to narrow from 5.8% in FY24-25 to 5.0% in FY25-26, reaching 2.4% in FY30-31. The general government debt ratio is forecast to peak at 105.0% of GDP in FY29-30, before edging down to 104.8% in FY30-31.
The OBR raised its annual growth forecast for 2025 to 1.5% from 1.0% in March 2025 and, as widely expected, reduced its 2026 forecast to 1.4% from 1.9%. It now expects lower growth of 1.5% annually from 2027 through the forecast horizon, reflecting weaker medium-term productivity growth. Policy adjustments raise headroom to GBP 22 billion, but the buffer remains slim by historical standards, limiting shock-absorption capacity. In addition, medium-to-long term spending pressures related to ageing demographics, the net zero transition, and defense continue to pose risks of future fiscal slippage. The OBR forecasts are slightly above our latest estimates of consensus but appear reasonably prudent and could give the government some room to outperform its fiscal targets. On the other hand,
further efforts may be needed if growth underperforms.
While the consolidation path still appears somewhat unambitious, steady progress should help maintain stability in the UK's credit rating. Gradual increases in taxes could have some dampening effects on growth over the next several years, but the Bank of England is positioned to continue monetary easing as necessary to support demand. The impact of the minimum wage hike is likely to be limited, though it could at the margin add to domestic price pressures, given that services inflation remains elevated. The government's tighter fiscal stance should also help reduce medium-term borrowing expectations and could ease upward pressure on long-term gilt yields.
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