The UK is preparing for its first Budget under the new Labour government, with Chancellor Rachel Reeves facing fiscal challenges.
Analysts at UBS predict that the government will exceed its spending forecast by £22 billion, equivalent to 0.8% of GDP. However, existing fiscal rules limit the government's ability to increase spending.
UBS expects the upcoming Budget to focus on adjusting fiscal rules, increasing taxes on capital gains, inheritance, pensions, and national insurance contributions for employers, as well as increasing spending on investment projects.
The Treasury's current strategy aims to achieve a balanced current budget by the fifth year of the Office for Budget Responsibility's forecast. This could potentially free up £13.6 billion, or 0.5% of GDP, for departmental budgets.
The specifics of changes to the debt rule are yet to be confirmed, but it could unlock between £16 billion and £58 billion for capital spending. UBS predicts that the government will adopt a cautious approach, creating an additional fiscal space of £16 billion, or 0.6% of GDP.
However, the government's commitment to avoid austerity requires additional funding of £26 billion, or 1% of GDP, which will likely be achieved through tax increases.
The government has pledged not to raise income tax, national insurance contributions, VAT, or corporation tax, so the focus of tax increases is expected to be on capital gains tax, inheritance tax, and pension-related taxes.
The overall target for additional tax revenues is uncertain, with estimates ranging from £20 billion to £40 billion.
UBS anticipates an upward revision of the gilt remit for the fiscal year 2024-25, increasing it from £278 billion to £292 billion. These adjustments in the gilt remit are important for understanding the government's borrowing strategy and its impact on the bond market.
The implications of the Budget will be closely watched by various sectors, as it will influence investor sentiment and economic stability.