Thursday 27th November 2025
The rumoured income tax rise did not materialise, with the Chancellor instead choosing the quieter and more subtle option of extending income tax band thresholds for several years, thereby increasing the tax burden at a later point perhaps even at a higher level. Whilst manifesto promises may not have been broken literally, they have in principle.
But what options were available to the Chancellor?
Cutting public spending was a seemingly unpalatable choice, and with low economic growth it was inevitable that tax rises were required to meet the fiscal rules. Referring to these rules as ‘ironclad’ all but ensured that any future day to day spending would have to be funded by tax receipts.
Maintaining the fiscal rules
What the budget did do however was demonstrate that the government was not for bending on their fiscal rules. Maintaining this policy consistency despite the budget pressure was a very important message to send to the markets, upon which the government relies to fund the current account deficit. The gilt market responded with a small reduction in borrowing rates, with the 10-year yield staying below 4.5%.
The country has significant public sector debt, standing at 94.5% of GDP, with the cost of interest amounting to £111bn or 8.3% of total public spending according to the Office for Budget Responsibility (OBR). Whilst this is significant, it does reflect two key events being the 2007 financial crisis (of which the UK was especially sensitive) and the 2020 pandemic. It is now a matter of having to work through and/or grow into this debt but meanwhile responsibly service it to keep costs as low as possible. The opposite approach of unfunded spending would not be acceptable to the markets, as was found with former Prime Minister Liz Truss.
Given the headwinds, it might be considered that avoiding an economic downturn by being fiscally responsible is the preferred route out of the structural malaise the UK finds itself. Granted, you cannot tax your way to growth, but a ballooning cost of servicing debt would be a negative spiral to get caught up in.
Growth prospects
Targeting growth is tricky and indeed UK productivity was downgraded by the OBR, meaning that 2026 GDP growth is forecast to rise by only 1.4%, lower than the 1.9% forecast in March.
Brexit has evidently not helped in recent years and left scars by impacting productivity in different ways, as according to the Organisation for Economic Co-operation and Development (OECD) the UK is the only advanced economy of the 37 covered that in 2024 had average import and export levels below 2019. Whilst the lack of growth is a problem, we are not alone amongst the G7 advanced economies, indeed this year the UK is stronger than most.
Interest rates
With short-term inflation largely under control, albeit not back to target, and in the absence of significant demand in the economy, the Bank of England (BoE) is likely to offer support through interest rate reductions. This could come as soon as December, with a forecast fall of 0.25% to 3.75% expected, with further reductions to drive rates to nearer 3% expected in 2026. This will hopefully allow gilt market yields to fall further and therefore improve assumptions for fiscal headroom. The opposite could happen if an economic shock occurred and the UK would have little resilience to that.
The UK business environment remains tough. Higher minimum wage and national insurance levels, along with trade uncertainty, means that unemployment has started to rise. The Office for National Statistics (ONS) released a 5% unemployment rate earlier this month for the three months to September, the highest level since 2021. This further supports a likely interest rate cut next month to support economic activity. Higher unemployment means lower tax receipts but puts a cap on general wage growth as more labour becomes available.
Financial markets
In terms of financial markets, the UK domestically focused FTSE Small-Cap index responded positively to the budget but has performed poorly over the last year or so relative to the large and internationally focused FTSE All Share index. Listed UK companies on average remain lowly valued compared to other major stock markets such as the US, Europe and Japan on an earnings basis. The catalyst for a re-rating is difficult to identify, but it surely starts with consistency of government policy so that international investors once again look at the UK in a positive light. The stock market is not the economy, but ultimately company valuations follow a path of growing profitability.
In closing – it is fair to say it is unrealistic to expect improved economic growth over the next few years. A more realistic objective is to focus on getting the house in order and laying the investment foundations to increase productivity and drive genuine improvement which may only emerge much later down the line.