Article last updated 3 November 2025.
At Rathbones, we often look outwards, far beyond our shores, when writing about markets.
The UK wealth management industry has become increasingly global in both outlook and portfolio construction, in order to take advantage of the breadth of opportunities available.
With this global outlook, we’re thinking especially of global geopolitics, the dominance of US companies and the influence of the Federal Reserve.
But we’re still big investors in the UK too, on behalf of our clients. So, we keep thinking about the UK economy and markets – and even more so than usual in the weeks before the Autumn Budget, which comes this year on 26 November.
Chancellor’s challenges
One year on from the last Budget, Chancellor Rachel Reeves is yet again battling with the country’s stretched finances. She faces an impossible ‘trilemma’, stemming from the determination to hold true to the Labour Party’s promise not to raise rates for the three taxes that bring in the most revenue: income tax, national insurance and value-added tax (VAT).
Come what may, the books must be balanced – or, at least, the gap between spending and revenue can’t be so large that it will spook bond markets. This burden will likely fall on taxpayers. The broad consensus is that the Chancellor will require somewhere above £25bn to fill the oft-cited fiscal “black hole” – and possibly more if she seeks more ‘headroom’ to accommodate future fiscal shocks.
The full extent of tax increases will depend in part on the state of the economy. A slower-growing economy means less tax revenue for any given tax rate, which could mean higher tax rates to make up for this.
UK borrowing is quite high by historical standards
Public sector net borrowing as a % of GDP
The economic background
The economic picture is mixed.
The public finances for September showed a higher deficit than originally forecast. The cumulative shortfall so far this tax year is £99.8bn. This is roughly £7bn higher than the Office for Budget Responsibility’s (OBR’s) projections. And the OBR is expected to downgrade long-term UK GDP growth forecasts due to weaker trend productivity growth; this will widen the gap yet further, by reducing forecasted tax revenue.
Better news came in the form of September’s inflation data. It was below forecasts at 3.8%, while the core inflation rate fell unexpectedly to 3.5%. Because October’s energy price increases were lower than last year’s, the annual rate of inflation is likely at its peak for now.
However, inflation remains high enough to restrict the Bank of England’s ability to reduce interest rates. Interest rates matter to the Chancellor because the government pays interest on its debt. As interest rates rise or fall, so too does the deficit because the burden of interest payments is rising or falling.
Inflation cools but pressure remains
UK consumer prices rose 3.8% in September, coming in below forecasts and offering some relief for households. But the rate is still high enough to limit the Bank of England’s room to cut interest rates.
What might Reeves do?
Reports suggest that Reeves is keenly aware of the pressure inflation places on people’s incomes. Thus, the idea of scrapping VAT on household energy bills has been put forward, and it seems unlikely that she will raise the basic rate of VAT or extend it to items on which there is currently no VAT.
Instead of a greater VAT burden, we could see another freeze in income tax thresholds..
More than that, speculation about a rise in income tax rates has mounted. This is because of a combination of media reports that the government is considering it, plus the refusal of prime minister Keir Starmer to rule it out (or rises in national insurance or VAT either) when asked about this in Parliament.
Freezing tax thresholds is described as “financial repression”, because it quietly increases the tax burden as incomes rise with inflation. For example, the starting income for paying income tax has been frozen at £12,570 since 2021-2. If it had risen in line with inflation, it would now be £15,520. Based on the same premise, the 40% income tax threshold should kick in at more than £61,000 rather than remaining stuck at £50,270. That means someone earning £60,000 pays around £2,500 more in tax every year.
Unless the UK can accelerate economic growth, it’s likely there will be more of this type of policy in the future. The latest GDP figures showed the economy grew 1.3% in the year to August. If inflation continues to fall, it will give the Bank of England scope to continue cutting interest rates. That would be welcome news, especially for those having to refinance maturing five-year mortgages taken out at rock-bottom rates in 2020.
What’s happening in the markets?
The FTSE 100 isn’t a reliable indicator of the UK economy because such a high proportion of its constituent companies’ revenue is from overseas. For that reason, weaker pound often boosts the index, as foreign earnings are worth more in sterling. For a clearer view of domestic trends, we need to look at sterling, government bonds (gilts), and smaller, UK-focused companies.
Overall, markets are calmer, ahead of the Budget, than some media headlines suggest. The pound is steady, partly due to a weaker dollar, but has slipped against the euro as investors favour the European currency because of the prospects of fiscal stimulus in the Eurozone, which could increase economic growth.
The gilt and sovereign bond markets have become more stable after a period of uncertainty, and investors aren’t showing signs of unease. Some analysts even suggest if the upcoming Budget sets Britain on a sustainable fiscal path, it might be a turning point that changes – for the better – how investors feel about UK government bonds.
The UK’s fiscal situation, in terms of its gross debt-to-GDP ratio, is better than for most G7 peers except Germany, although Germany’s plans to spend will increase its government debt. Few governments seem willing or able to embark on the austerity route, and this broader context is important in portfolio construction: if the UK was an outlier on debt we’d think differently about gilts, but it’s not.
With only weeks to go till the Budget, the Chancellor faces no easy choices – but financial markets are not panicking.