By Katharine Neiss, chief European economist at PGIM Fixed Income
We expect Chancellor Rachel Reeves to unveil a cautious Budget tomorrow, which will likely be complemented by continued watchful monetary policy by the BoE.
There are many reasons for Reeves, who is cautious by nature, to show restraint. First, the strength of Labour’s election victory this year – as well as the lack of credible opposition in the Tory leadership contest – should keep the government focussed on the long term.
Next, the revenues from the tax increases outlined in the Labour manifesto are now expected to be far lower than initially touted – as the numbers were simply too optimistic. There is also the risk of a recessionary downturn, which would put more pressure on the public purse.
Further, it may be sensible for policymakers to remain vigilant, particularly as the market’s reaction to the mini Budget of 2022 is still fresh in the memory. The US election is just days away too, and it could be valuable to wait before making any large policy decisions – given the outcome across the Atlantic could result in major spillovers to the UK.
Even if a larger fiscal envelope could be agreed without triggering a negative market reaction, it is likely not feasible to spend this money today due to supply constraints, such as skilled labour. This requires structural reforms, which will take time to materialise.
Following recent media reports, we now expect a more substantial change in the fiscal measurement to incorporate PSNFL. This opens up significantly more fiscal space. That said, we expect the Chancellor to show restraint in the first budget, and commit not to use most of the additional space. The purpose would be to build credibility with markets and avoid a Liz Truss-type moment whilst simultaneously setting a vision for increasing investment further down the track. In a more favourable environment of lower rates – and possibly as early as next Spring – we would expect to see more of the additional fiscal space used to increase much-needed public investment.
