The UK Chancellor is preparing for a relatively quiet Autumn 2026 Budget, but with a significantly reduced fiscal buffer. The Office for Budget Responsibility (OBR) had previously identified a £23 billion headroom in March, but this is now expected to be around £10 billion lower. This reduction implies higher borrowing in the coming years, which raises concerns about fiscal credibility.
NIESR analysts Ben Caswell and the author argue that borrowing more at this time is not justified. They highlight three key reasons: the economy does not need a fiscal stimulus, borrowing costs appear persistent rather than temporary, and financial markets are already volatile. The authors suggest that strengthening the fiscal position is the better course of action, especially given the heightened risk outlook.
The UK economy has shown remarkable resilience, with GDP growth of 1.8% so far this year, exceeding trend estimates. Unemployment is also lower than expected, while inflation is rising, reaching 3.5% in September. The authors warn that inflation could exceed 4% in early 2027, increasing the risk of persistent price pressures. Markets are already pricing in significant interest rate hikes, and looser fiscal policy could exacerbate this trend.
The rise in borrowing costs is partly due to global factors, including the conflict in the Middle East and higher inflation expectations. However, around two-thirds of the increase is likely to be persistent, driven by higher real interest rates and increased government borrowing worldwide. This makes the debt arithmetic more challenging, as higher interest rates require stronger economic growth to keep debt stable.
Financial markets are currently sensitive to potential weak links, and the UK has faced bond market scrutiny twice in recent years. A credible Budget could reduce gilt yields by 10 to 20 basis points, saving £1 to 2 billion annually. Conversely, an uncredible Budget could lead to much higher borrowing costs. The minimal test of credibility would be ensuring that any additional borrowing is offset by lower borrowing in later years, maintaining the planned debt-to-GDP path.