On Tuesday, Chancellor Rachel Reeves started preparing the markets and general public for what is coming in the Autumn Budget later this month – likely more fiscal discipline and potentially some tax rises.
Bond markets took it as a sign that the government remains committed to keeping the public finances under control, and gilts rallied with 30-year yields sliding 4 basis points. However, although investors interpreted the speech as fiscally cautious, the absence of concrete details caused the rally to fizzle out.
Here we look at four scenarios of how the Autumn Budget could play out, with the help of ING analysts.
Base scenario
The broad outline of the budget is now both well-recognised and well-priced.
Rachel Reeves faces a fiscal shortfall of roughly £25bn per year. That is likely to be made up through a combination of extending the freeze on tax thresholds, extending national insurance to landlords and partnerships, raising bank taxes as well as tax on dividends and certain types of capital gains.
“The Treasury is loath to do anything that might add to inflation, even if its scope to lower it is limited,” said ING. This means that gilt issuance should fall next year in line with the Debt Management Office’s projections. The DMO plans gross gilt sales of £299.2 bn in 2025-26, with issuance split between auctions (£231.7 bn) and syndications (£40bn), along with an unallocated portion of £26.7bn.
“Delivery of all of that could help remove some or all of the remaining risk premium in gilts, although that is only probably worth an extra 5 basis points of 10-year yields,” said ING. “That suggests that the recent gilt rally could be reaching its limit for the time being.”
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Second scenario: The Chancellor doubles down on fiscal tightening
In the second scenario, the Treasury could deliver more significant tax hikes, coupled with credible cuts to public spending. These combined could fuel a further rally in gilts. A potential move would likely involve raising the basic rate of income tax (a 1pp increase would yield £8bn/year – something that could be interpreted from the Prime Minister’s comments in Parliament last week).
Those hikes could also be coupled with significant changes to pension taxation, delivering up to £10/bn a year. On spending, the government has hinted that it would like to revisit the welfare cuts it abandoned earlier this year.
“A scenario that alleviates stress in bond markets is likely to be GBP-negative, assuming it would also likely bake in even more BoE easing. The bottom line is that more fiscal tightening means another leg lower in short and long-dated yields, plus some modest further weakening in sterling,” said an ING report.
Third scenario: A prudent but inflationary budget
Given the BoE’s increasing focus on the current rate of inflation, there is growing recognition both in markets and at the Treasury that tax hikes, which add to headline Consumer Price Index (CPI), would limit the scope for further rate cuts next year. The most obvious example would be a hike in VAT, but also through levies on alcohol and tobacco. Another issue is the National Living Wage, expected to be around 4% this year following a 6.7% increase last year.
A budget which delivers tax hikes but pushes 2026 inflation higher would lift short-dated gilt yields and boost sterling because it would force the BoE’s hand on interest rates and limit the scope for further rate cuts.
Final scenario: A lack of action
If the government opted for tax hikes that don’t kick in until much later this decade, or for uncertain revenue-generating capabilities, increases in spending under a lack of fiscal headroom or opted for inflationary tax hikes or gilt issuance, then the market could see a spike in gilt yields. A big move would also be a change in fiscal rules, opening the door to more borrowing next year.
“If that happens, the upside to gilt yields is significant. The past few months showed that investors treated gilts more in line with riskier French OATs and Italian BTP bonds than with German Bunds. This shows that gilts remain sensitive to changes in risk sentiment,” said ING.
For the next three weeks, markets will be on tenterhooks trying to second-guess Rachel Reeves’s next move. As today’s trading showed, volatility may come in bursts — a big reaction that quickly fizzles out — while speculation remains the main force driving sentiment.
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