Investors brace for 'smooth-sailing fiscal event' but any relief in Sterling and gilts to be short lived

Both the pound and gilts have traded in a calm and orderly fashion ahead of this afternoon’s Autumn Budget, with investors bracing for a smooth-sailing fiscal event, barring any nasty surprises lurking in the small print. All signs point to a cautious budget that leaves the bond vigilantes with little to do.

Spending increases look set to be modest, with relatively small new commitments paid for by reallocating money from elsewhere rather than through extra borrowing. Healey will also need to rebuild the fiscal headroom eroded by the spike in gilt yields, and we think a buffer of around £15bn should be enough to keep bond traders onside.

Tax rises are all but certain, though they look set to be small and targeted, hitting banks, online retailers and gambling. With capital gains tax seemingly off the table, the immediate hit to growth should be minimal.

For sterling and gilts, we see the bar for a positive surprise as high. With a market-friendly budget priced in, the path of least resistance is lower for the pound and bonds.

Investors will want to see the headroom rebuilt to £15bn or more, spending plans that look credible rather than relying on cuts pencilled in for later, and tax rises that limit the risk of crowding out. A shortfall on any of these could quickly revive pressure on gilts and the pound. Ultimately, the budget looks set to buy Healey time rather than pull the UK out of its fiscal quagmire.

Today’s measures may be modest, but they extend a familiar pattern of plugging fiscal gaps with tax rises that weigh on the very investment needed to fund spending. Until the government breaks that cycle, any relief in sterling and gilts could prove short-lived.