• The first Labour Budget in 15 years saw a significant increase in tax, expenditure and investment plans. As expected, the fiscal rules have been adjusted to carve out more space for capital spending.
• The UK growth environment now looks favourable with hefty fiscal support added to falling interest rates and a stable business environment. There are upside risks to our already-above consensus forecast for 1.6% growth next year if the government front-loads spending as planned.
• Gilt yields have risen on the increase in issuance and implications for the BoE outlook. While we still expect a rate cut next week we are now less confident about a back-to-back move in December with hawkish MPC members likely to fear the effects of fiscal loosening in an economy with little spare capacity.

Higher tax, higher spend, more investment

The UK Budget announcement was broadly in line with expectations (see our preview here) with the government increasing tax and spend while also adjusting the fiscal rules to carve out more space for borrowing for capital investment. There were no nasty shocks – pre-announcement leaks helped with this – and measures were well-communicated. But, overall, the government went further than we expected, with more in the way of additional spending over the near-term.

The headline figures are a 40bn GBP increase in taxes by 2029-30 and a 70bn increase in spending. Borrowing is set to be increased by around 1% of GDP a year, according to projections from the OBR. That represents a significant fiscal loosening.

Of the new tax rises, the most significant by far is the 25.7bn increase in employer national insurance contributions, which will increase by 1.2pp from next April. Most of the effect of this is likely to be borne by employees through lower pay settlements over the next year or two, with some impact on profit margins too. Indeed, the OBR estimates that the change will actually generate only 16bn once accounting for knock-on effects. There were also a range of smaller measures including increases to capital gains tax rates and the introduction of VAT on private school fees. However, the previous government’s freeze on income tax thresholds, which results in more workers being dragged into higher bands, will not be extended beyond 2028 (which just so happens to be the year before the next election). The overall tax as a share of GDP is still set to increase to around 38%, a historic high.

Chart 1: A significant increase in borrowing

Chart 2: Tax share to rise sharply over coming years

On new spending, it’s roughly a 2:1 split between current and capital expenditure, and is very front-loaded. The OBR sees current spending increasing by close to 5% this year and 3% next year – a hefty increase – before falling back to an average of 1.3% later in the forecast horizon (which extends to 2029-30). Given pledges to significantly increase spending in certain areas (e.g. education, healthcare, defence) this still implies an ongoing real-terms squeeze on other departments’ budgets, despite the headline overall spending increase.

On capital spending, the government’s plans point to a rapid 10% real terms increase in 2025-26. With long lead-in times we suspect that might be hard to achieve in such short order and spending could be spread more gradually over the horizon. There will be more details on the specifics of spending targets in next spring’s Spending Review.

The government has carved out room for capital spending with new fiscal rules

The space for this increase in borrowing to fund investment was generated by significant changes to the government’s fiscal rules with 1) a shift to the current budget as a target, rather than overall government balance, and 2) changing the balance sheet metric to “public sector net financial liabilities” rather than “public sector net debt ex. BoE” as it was previously. Both these changes were expected, with the first in Labour’s manifesto and the second leaked prior to the announcement. Table 1 shows the new and previous targets (which we would highlight have frequently been changed by previous administrations).

Table 1: UK fiscal rules since 2015

The market response to the large increase borrowing and the change in fiscal rules has been relatively muted. Gilt yields moved upward after the announcement and details of the higher issuance, but ultimately settled only slightly higher on the day. At the time of writing the 5Y yield, at 4.3%, is around 25p up on the week and this in part reflects shifting expectations around the path ahead for BoE rates.

Overall, market participants seem fairly sanguine about a degree of higher borrowing to fund investment. There is a consensus this could be positive if used well – the IMF and OECD have both argued for higher UK public investment. That said, it looks a narrow path for the government to walk. We were surprised that the government has left itself relatively small headroom against its new targets – just 0.3-0.4% of GDP. This could easily be erased in the event of a macroeconomic shock.

Table 2: OBR projections of fiscal rule metrics – current and previous

The medium-term UK growth outlook looks bright

In terms of base scenarios, this Budget poses upside some risks to our already above-consensus view on UK growth (MUFG 1.6% in 2025 vs cons. 1.3). The medium-term UK growth backdrop looks favourable with significant fiscal support added to falling interest rates and what is now set to be a stable policy environment. The government’s messaging prior to the Budget (with the PM explaining it would be “painful” months in advance) unsurprisingly weighed on consumer and business sentiment in recent months, with officials opting not to shut down speculation around specific measures. But, in the finish, the budget bark was worse than its bite – most households will not see any immediate or direct costs as a result of yesterday’s policy choices. There is scope for confidence indicators to improve over coming months.

We do note the deceleration in growth further ahead in the OBR’s horizon with later GDP projections now lower than in the previous estimate. On this, Chart 3 is the key image from the new outlook document (here). The OBR believes that the increase in public sector spending will crowd out more efficient private sector spending and reduce potential growth rates by around 0.2pp by the end of the horizon. We’d stress that there’s a lot of uncertainty around these estimates.

Our broad view remains that a more stable business environment (once the dust has settled on this Budget) will be beneficial. The government seems to recognise that a return to relative calm and stability after the turbulence of the Brexit years would be beneficial and we believe that, all else equal, this should support private sector activity and may in fact result in some ‘crowding in’ of foreign direct investment alongside public capex.

Chart 3: The OBR expects a short-term growth boost with public investment then crowding out private investment

Chart 4: The OBR’s growth forecasts have been revised lower later in the projection horizon

So, in the absence of a negative shock, our view is that UK growth will be at or above potential rates over the medium-term. This has implications for the BoE outlook, with policymakers set to meet next week. A November rate cut is still highly likely after the shift in communication following the hold in September (see here). But the MPC is plainly very divided – the 5-4 vote to get the ball rolling on rate cuts showed that – and this budget will certainly provide more ammunition for the hawks who will fear the effects of fiscal loosening in an economy with little spare capacity. A back-to-back cut in December now looks less likely than it did prior to the Budget. Officials may also be less sure of estimates of ‘neutral’ (which already came with a high degree of uncertainty) after the uptick in UK public investment.