United Kingdom: Constrained backdrop and BoE risks – Societe Generale

Societe Generale’s Sam Cartwright argues that a new UK Prime Minister has not altered the constrained fiscal backdrop, limiting ambitions on housebuilding, social care, investment and defence. The Autumn Budget is seen focusing on a defence uplift and day-to-day spending, with larger social care reforms delayed. Cartwright highlights that higher capital borrowing could lift gilt yields and challenge the Bank of England rate-cut path.

Fiscal limits and monetary implications

"A new Prime Minister has not changed the UK’s constrained fiscal backdrop. Burnham's ambitions on housebuilding, social care, investment, and defence may therefore prove difficult to deliver, even if the government uses the additional 'flexibility' in the fiscal rules."

"Even before any policy announcements, fiscal headroom at the Autumn Budget could be £11.5bn lower than projected in March, owing to the US-Iran conflict weighing on growth and pushing up interest rates. In this scenario, a favourable revision to wage growth could instead boost headroom by around £10bn. If the Iran-US situation improves, the deterioration in headroom could be as little as £5bn, but could rise to £23-43bn if it worsens."

"Autumn Budget likely limited to a defence uplift to 3% of GDP and reversing the planned slowdown in day-to-day spending Combined with the deterioration in the pre-measures forecast, we think these costs can be offset through welfare reform, spending reprioritisation, modest tax rises and the use of remaining headroom."

"A 0.3% of GDP a year increase in borrowing to fund capital spending could put our BoE call at risk and raise gilt yields by just under 20bp We currently forecast Bank Rate remaining unchanged at 3.75% in 2026, followed by 75bp of easing in 2027. However, our macro model suggests this higher borrowing could raise Bank Rate and 10-year gilt yields by around 10-20bp over the first three years, posing a risk to our view that Bank Rate falls to 3%, with 3.25% a plausible alternative."

"Risk of a loosening in the fiscal rules One risk is that Burnham's housing and investment ambitions prove difficult to deliver within the existing fiscal rules, increasing the likelihood of higher borrowing through a later loosening of the rules, for example by switching the debt target to public sector net worth, exempting defence spending, or extending the horizon for meeting the target."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)