Vasileios Gkionakis, senior economist and strategist at Aviva Investors, gives his initial reaction to the UK spring budget, outlining what it might mean for UK financial markets and sterling.
Read this article to understand:
- How we see financial markets reacting to the Spring Statement
- What it might mean for interest rates
- Why gilts remain in a vulnerable position
The UK government on Wednesday announced cuts in government spending to rebuild ‘fiscal headroom’ after rising government borrowing costs and anaemic economic growth badly damaged its finances.
Chancellor Rachel Reeves says the mix of cuts in welfare benefits and departmental spending and the indirect effect of higher tax receipts will reduce the government’s total outlays by £14 billion by fiscal year 2029/30. That will in turn replenish the so-called headroom to £9.9 billion.
The statement was accompanied by news the Office for Budget Responsibility, the UK’s fiscal watchdog, had sliced its 2025 economic growth projection in half to 1.0 per cent, although it has increased growth forecasts for subsequent years.
Reeves’s spending cuts come less than five months after her inaugural budget and have essentially been forced upon her by the gilt market, with yields having recently hit their highest level in more than 16 years. A stagnating economy has also contributed to the worsening outlook for public finances.
Figure 1: Ten-year gilt yield
Source: Aviva Investors, Bloomberg. Data as of March 19, 2025.
Increases in interest rates since October have raised the cost of government borrowing. The OBR expects debt interest spending to total £104.9 billion in the current fiscal year. That would represent 8.2 per cent of total public spending and is equivalent to more than 3.7 per cent of national income
The estimated £10bn of fiscal headroom from her October Budget has been wiped out by rising borrowing costs and a weak economy
In her October Budget, Reeves had estimated she had £10 billion of fiscal headroom but that has been wiped out by rising borrowing costs and a weak economy. With public sector net debt as a share of economic output at its highest level in more than fifty years, any further rise in bond yields threatens to wreak havoc on the government’s finances.
Although Reeves will see her cuts as necessary, they are causing a backlash from some Labour MPs. This means further welfare cuts would be a very hard sell. The chancellor may have to hike income taxes in this autumn’s budget, rowing back on the government’s manifesto pledges. Alternatively, she might try to alter her fiscal rules, although this is unlikely, as it would most likely be very badly received by the gilt market.
UK government bond yields declined slightly in the aftermath of Reeves’s remarks, although this had less to do with the contents of her speech than news the debt management office expects to issue slightly fewer bonds in the fiscal year to April 2026 than previously anticipated.
Indeed, since Reeves’s latest fiscal numbers contain several optimistic assumptions, the statement arguably has done little to alleviate market concern as to the strength of the UK’s commitment to fiscal discipline.
The statement has done little to alleviate market concern as to the strength of the UK’s commitment to fiscal discipline
Despite these cuts, public sector finances remain in a parlous state, not least given sluggish economic growth. After all, the OBR’s downwardly revised economic growth projections still look slightly optimistic. We believe output is likely to expand by closer to 0.9 per cent.
Importantly growth momentum is very weak and hikes in employer taxes will continue to depress employment growth. It is for this reason the Bank of England is likely to cut rates more aggressively than is currently being priced into UK interest rate markets. While inflation is above target and set to rise further, this is largely due to recent rises in utility bills. They are unlikely to lift inflation expectations materially.
Thereafter, the weakness of the economy should ensure inflation begins falling, which will be enough to enable policymakers to begin turning dovish and cutting interest rates.
