Key Takeaways
- The UK government’s financial position is not as bad as initially suggested, with the Office for Budget Responsibility (OBR) forecasting a better-than-expected economic growth
- The Chancellor, Rachel Reeves, has frozen income tax thresholds for a further three years, which will result in most people paying more tax
- The Budget borrows to spend on political priorities in the short term, but taxes hard to get borrowing down in the long term
- The government hopes that growth will exceed predictions, which could avoid the need for extended threshold freezes and enable the Bank of England to cut interest rates further
- The Budget has been well-received by the Labour left and financial markets, with the effective interest rate on government bonds decreasing
Introduction to the Budget Surprise
The biggest initial surprise in the Budget may have been that the government’s independent forecaster, the Office for Budget Responsibility (OBR), managed to publish it all by mistake long before Chancellor Rachel Reeves got to read it out. However, the real surprise was that the government’s financial position is nowhere near as bad as had been suggested in the run-up. The OBR forecast shows that the economy is expected to grow more slowly than expected due to downgraded long-term productivity, but it also starts from a better base thanks to outperformance and upgrades this year. Additionally, higher wages due to high inflation have boosted the Treasury’s tax take, and the OBR has made a judgement that Artificial Intelligence (AI) could boost productivity by a notable and growing amount by the end of the year.
The Chancellor’s Decision to Freeze Tax Thresholds
The net result of all that is the OBR forecasts show that the Chancellor could have met her self-imposed rules of only borrowing to invest and cover day-to-day spending with tax receipts, without freezing income tax thresholds. However, she has chosen to freeze thresholds for a further three years until 2031, which will result in most people paying more tax, including pulling almost one in four people into the higher rate tax bracket. If it wasn’t for her U-turn on welfare reforms, she would have been on track to actually meet her target by a whisker before she made any changes to tax and spending. This decision has been seen as a way to buy breathing space, both politically and economically, by borrowing to spend on political priorities in the next year or so, and then taxing hard to get borrowing down in the final years of the decade.
The Budget of Two Halves
This Budget can be seen as a story of two halves. In the short term, the government is borrowing to spend on political priorities, such as alleviating child poverty, lowering energy bills, and freezing rail fares and prescriptions. This has been well-received by the Labour left and has helped to shore up the government’s immediate position in parliament. In the long term, however, the government is taxing hard to get borrowing down, with taxes expected to go up to new records in 2028. This is seen as a way to create breathing space, both politically and economically, and to reduce the speculation about missing borrowing targets that has been a force for instability and lack of credibility over the last year.
Market Reaction and Economic Growth
The net result of all this and a slightly lower than expected issuance of UK government bonds was that markets were more than calm, with the effective interest rate on government bonds decreasing across the board. The message has been heard in the markets, and at first glance, in the Chancellor’s own party. However, this has come at a price, with taxes expected to go up to new records in 2028. The government hopes that growth will exceed the solid pedestrian predictions of 1.5%, which could avoid the need for extended threshold freezes and enable the Bank of England to cut interest rates further. There is some space for green shoots to sprout now, or at least for the animal spirits of the economy to emerge from non-stop chaos, which could apply to business investment plans and those older consumers who have been hoarding savings and not spending.
Conclusion and Future Prospects
In conclusion, the Budget has been a surprise, with the government’s financial position not as bad as initially suggested. The Chancellor’s decision to freeze tax thresholds has been seen as a way to buy breathing space, both politically and economically. The Budget of two halves, with borrowing to spend in the short term and taxing hard in the long term, has been well-received by the Labour left and financial markets. However, the success of this strategy depends on economic growth exceeding predictions, which is no guarantee. Nevertheless, there is some space now for a more stable backdrop, and the government hopes that growth will come, enabling the Bank of England to cut interest rates further and avoiding the need for extended threshold freezes.