UK Chancellor Rachel Reeves unveiled a fiscal plan on Wednesday that balances the budget largely by delaying most tax hikes and spending constraints. This means British households and businesses will begin feeling the pinch of higher taxes from the 2028-29 fiscal year, facing austerity measures worth up to £26 billion ($34.4 billion) the following year. However, the UK must hold its next general election by August 2029 at the latest.
Against the backdrop of plummeting public support for the ruling Labour Party, both S&P Global Ratings and Moody's have raised doubts about Reeves' ability to implement the plan. While both agencies maintain high-quality sovereign credit ratings with stable outlooks for the UK, Moody's flagged "elevated execution risks," warning that departmental spending plans "will be difficult to enforce in an election year." The government now projects real departmental day-to-day spending growth at just 0.5% for 2028-29 and 2029-30, down from previous estimates of about 1%.
S&P expressed similar concerns about postponing major austerity measures to the later years of the five-year fiscal plan, cautioning that the Chancellor might be forced to alter course. "The next UK general election is due in 2029, shortly after significant tax measures take effect in 2028. This raises the possibility of the current government rolling back some announced austerity policies as the vote approaches," S&P noted.
Reeves formally presented the Autumn Budget 2025 in Parliament on Wednesday. The same day, the UK Office for Budget Responsibility (OBR) released its latest Economic and Fiscal Outlook, confirming the government's fiscal headroom had more than doubled from March 2025's £9.9 billion forecast to £21.7 billion. According to OBR estimates, the budget's policies will generate approximately £26.1 billion in additional tax revenue by 2029-30. Other data shows total tax increases reaching £29.8 billion, primarily targeting gambling, high-end property, and investment income.
The OBR highlighted that about three-quarters of planned borrowing reductions over the next five years will come from tax hikes. If this trend continues, taxes as a percentage of GDP will hit a record 38% by 2030-31. While the budget honored campaign pledges not to raise income tax, National Insurance, or VAT rates, it expanded the tax base through various "stealth" measures. Key policies include extending the freeze on income tax and National Insurance thresholds for three more years to 2030-31. The OBR estimates this "fiscal drag" will push nearly 2 million taxpayers into higher brackets, generating £8 billion in additional revenue by 2029-30.
The budget also included measures to ease household cost pressures, such as freezing rail fares, extending fuel duty cuts, and reducing energy bills. The OBR calculates these policies will lower inflation by 0.5 percentage points in Q2 2026.
**Political Tightrope Walk** This marks Labour's second budget since taking office. With sluggish growth, high public debt (94.5% of GDP as of October), and strained public services, Reeves sought to balance election promises with fiscal consolidation. While avoiding radical austerity, the budget strengthened the fiscal framework through structural tax increases and spending controls, alleviating bond market concerns about fiscal slippage.
Economic Secretary Lucy Rigby called the budget "foundational for the UK economy," reiterating the government's commitment to reducing debt-to-GDP. Financial markets responded positively, with analysts noting expanded fiscal headroom boosting confidence and giving the Bank of England (BoE) more policy flexibility. Traders fully priced in a BoE rate cut at the December 18 meeting, though subsequent moves hinge on inflation retreat and economic resilience.
Deutsche Bank analyst Sanjay Raja called the budget "better than expected," suggesting doubled fiscal buffers could lower inflation and pave the way for BoE easing. Berenberg senior economist Andrew Wishart added that tighter deficits support rate cuts. However, Institute of Directors chief economist Anna Leach noted the budget did little to improve growth prospects, while NIESR director David Aikman warned the government remains unlikely to avoid future fiscal resets amid high uncertainty.
**Inflation Challenges Persist** The OBR revised its 2025 GDP growth forecast up to 1.5% from 1.0% but cut 2026's projection to 1.4% from 1.9%. More concerningly, it slashed medium-term productivity growth from 1.3% to 1.0%, reflecting structural weaknesses. Despite sticky core inflation, the OBR expects budget measures to trim inflation by 0.5 percentage points in Q2 2026.
Yet austerity risks exacerbating service inflation through cost passthrough. Tax hikes—including frozen employer National Insurance thresholds, tighter pension tax rules, and reduced capital allowances—could raise business costs, feeding into prices. With services comprising over 80% of the UK economy, core inflation (still at 3.4% YoY in October 2025) may prove persistent.
BoE officials have repeatedly stressed "one-sided" service inflation and resilient wage growth, noting stealth taxes complicate disinflation. Despite improved fiscal buffers, the OBR's downgraded growth and potential output forecasts highlight productivity stagnation and weak investment. With unemployment at a four-year high and retail sales below pre-pandemic levels, the BoE faces a dilemma: cutting rates too soon risks undermining inflation-fighting credibility, while holding rates could further dampen fragile demand.
Divisions are emerging within the BoE, with some members advocating cuts to support weak demand while others stress maintaining restrictive policy until inflation clearly converges to 2%. Post-budget, the central bank will likely adopt a "wait-and-see" approach—keeping rates at 4.00% until core inflation sustainably falls below 2.5%, slowing quantitative tightening to manage liquidity, and emphasizing policy independence to avoid appearing to compensate for fiscal tightening.
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