The likelihood of an investor confidence crisis in UK assets after last week’s Autumn Budget “remains live” and markets will “gradually lose faith” in the government’s fiscal plans despite the initial reaction being largely positive, an economics consultancy has said.
A fresh analysis published by Oxford Economics said the government’s frontloaded spending and backloaded tax rises, and behavioural responses to the glut of tax rises announced, will lead investors confidence in the fiscal prudence to diminish.
“We think that confidence will dwindle as markets question the credibility of the package,” wrote chief economist Andrew Goodwin. “This will likely result in a slow burn of rising risk premea and a falling pound.”
Goodwin also said a “more sudden loss of confidence” could come transpire should any unfavourable surprises emerge, like a further bout of leadership speculation or ministers caving to the spending demands of a restive cohort of Labour MPs.
Autumn Budget speculation over bond market fallout
In the days leading up to the Budget, investors had feared that the Chancellor’s climb down from a telegraphed plan to hike income tax in favour of a ‘smorgasbord’ of multiple different revenue raisers risked a sharp market reaction.
The overall tax take from multiple different smaller taxes is harder for markets and official forecasters to estimate.
And leaks in the media suggested that some of the measures – like mansion tax on properties worth more than £2m – would be a new tax entirely and take years to implement.
The Autumn Budget largely met those concerns, with spending pledges introduced immediately and some of the tax rises not coming into force until 2028.
But thanks to the Chancellor’s decision to more than double her ‘fiscal headroom’ – the leeway she has against her self-imposed fiscal rules – and most of the measures not being inflationary, bond and currency market fallout was muted.
The cost of government borrowing was also kept down by a decision from the Debt Management Office – which controls UK bond sales – to skew the gilt issuance to the shorter term.
Lower supply of 10- and 30-year bonds, the interest on which has been higher than shorter term in recent months, will help keep the yield down on longer-dated bonds down by matching demand levels.
Oxford Economics said the calm response was “unlikely to last”, highlighting the prospect of painful U-turns redolent of those after the 2024 Autumn Budget, and the fact the package contained no measures to boost economic growth.
“The risk of a sudden confidence crisis remains live,” wrote Goodwin, who added: “The backloaded nature of the measures and uncertain impact of many of the tax-raising measures, a lack of spending restraint and the absence of growth measures undermined the credibility of the package.”