In this week’s budget (Wednesday, 26 November at 12:30 pm), UK Chancellor Reeves looks set to fill a fiscal hole of around £20bn avoiding politically sensitive income/other tax rates that Labour ruled out in its manifesto. We can expect a further £5-10bn of tax rises to raise headroom. The total fiscal tightening should be just shy of 1% of GDP at the point the fiscal rules need to be met (2029-30). We see extra gilt issuance of around £6bn in the current fiscal year (£305bn). Assuming a fiscal hole of £20bn does not include adjustments to the fiscal headroom, then we expect a net fiscal tightening of between £25bn and £30bn to incorporate a rise in the headroom by £5-10bn from its previous £9.9bn. For the purposes of the macro-outlook, two things matter most in this budget: First, the size of the fiscal gap that has opened up, plus any changes that the Chancellor makes to the headroom around her fiscal rules as the sum of these indicates how much net fiscal tightening must be implemented. Second, how the fiscal tightening is distributed over the years of the forecast. While a more front-loaded fiscal tightening and a larger fiscal gap to fill would have even more significant repercussions for the macro -outlook, we still think a more modest backloaded tightening will be sufficient to keep the pressure on the Bank of England to cut interest rates further, and expect 25bp rate cuts each in December and April. To the extent that i) some fiscal measures will likely aim to reduce inflation, and ii) this inflation reduction pulls down on inflation expectations, there may be downside risks to market’s current terminal rate view of 3.35%. On incremental gilt issuance, assuming no major policy changes prior to the start of the next fiscal year (2026-27), we assume the miss on the deficit will show up in an additional financing need of £6bn, i.e. £305bn total for the year versus £299.1bn previously. The Bloomberg consensus expects £9bn higher gilt issuance in 2025-26 (i.e. to just over £308bn). We remain bullish on UK 10yr Gilts as we have written in our opinion piece & trade recommendation pieces written on 15th Nov & 16th Nov. Following was our trade recommendation on 16th Nov: BUY 10 YEAR UK GILTS (YIELD 4.58), TP 4.20 & SL 4.80.
