UK Budget risks 'skewed to the downside', additional tax hikes are 'inevitable'

Consider this our amuse-bouche: a small taste of what to expect from the Autumn Budget ahead of our dedicated preview report, which will go into far more detail in the coming week.

For now, sterling continues to hang in there - the pound has risen to 3-month highs on the euro this week, though gilt markets remain fragile. The 30-year gilt yield has touched 6% for the first time since 1998, which by some estimates has cut Chancellor Healey’s fiscal headroom by around two-thirds from a historically modest £23.6 billion at the Spring Statement to as low as £8.5 billion now. Reports suggest that the Treasury may be willing to accept a thinner buffer.

While this would lessen the need to return to the fiscal well, we don’t think that this would be welcomed by bond markets.

With yields surging, borrowing running ahead of the OBR's forecasts and debt-servicing costs climbing, we think that additional tax hikes are inevitable. We expect Labour to honour their pledge not to touch the "big three" taxes, so the burden could fall on property, wealth and capital, with changes to the mansion tax, tax on holiday lets and capital gains all reportedly on the table.

If the chancellor leans more on spending restraint and targeted tax hikes, rather than borrowing more or loosening the fiscal rules, then sterling and gilts could emerge unscathed.

Yet even modest spending hikes, such as the reported £1 billion of energy support, could be enough to spook investors - less due to the size of the package, more the signal that it sends. We remain of the view that risks to GBP heading into the budget are skewed to the downside.