What to Expect From the UK Budget

Andrew Sheets (0:00)

Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.

Bruna Skarica (0:06)

And I'm Bruna Skarica, Morgan Stanley's Chief UK Economist.

Andrew Sheets (0:10)

Today, the UK makes a budget, why it matters, and more generally, what we've gotten right and wrong about the country. It's Wednesday, October 14th at 2 p.m. in London.

Bruna, it's great to be here talking with you, and I'd like to get into a bigger discussion on the UK and what we've gotten right and wrong about the direction of the country this year. But more immediately, it has a very big event coming up. What is the budget, and why is there so much focus on it?

Bruna Skarica (0:40)

The budget is the UK's key fiscal event. It is the time of year when the Chancellor receives a refresh of economic forecasts and decides whether he needs to respond to these, whether there's any spending cuts or increases that are required, and whether there's any tax hikes or potentially tax cuts that are required too.

All with the view of ensuring fiscal consolidation and executing on what is a self-imposed fiscal framework. Here in the UK, the main target for the Treasury is to achieve current budget balance in year three of the forecast. The fiscal war shock forecasts five years of economic variables, and the idea is by the third year, we ought to be spending outside of investment expenditure as much as we're receiving in tax receipts. So all of that happens once a year in the budget.

Andrew Sheets (1:26)

Now, I might just stop you there, because in the context of these other budget pictures that we see around the world, the US is running a large budget deficit, France is running a large budget deficit, Japan is increasing its budget deficit. That actually seems like a quite ambitious goal in the next three years to balance that outside of the interest expenses. Can you just talk maybe a little bit more about that process and the thinking behind it?

Bruna Skarica (1:50)

Yeah, sure. The idea really is to ensure that over the next five years, not only do we get the current budget balanced while allowing for borrowing for investment, which is of course a favorable way to borrow because it boosts growth, but also that within the five year period, we're able to get debt to GDP ratio down. In order for that to happen, we need to be running a primary surplus of around one and a half percent of GDP.

Now, very often in UK macro, we tend to look at three year forecasts, five year forecasts, we talk about medium term headrooms, but I think it's important here to take stock of where we are at this moment in time. We think that in this fiscal year, 26, 27, primary deficit, our entire expenditure outside debt servicing costs minus tax receipts, we see that at just under 1% of GDP. The IMF is a little bit above 1% of GDP for UK. But for example, the IMF sees French primary deficit at 2.9% this year with the US measure forecast at 4.9%. So already UK has actually made a lot of progress in its consolidation path.

Andrew Sheets (2:57)

And Bruna, talking about this announcement specifically, could you maybe talk about just one or two items that you'd be on the watch for as potential surprises or decisions that the market is really focused on?

Bruna Skarica (3:10)

Sure. So we do know that the Treasury is looking at ways of alleviating some of the pressures stemming from higher inflation. Higher energy inflation in particular. So the scale of support that will be provided to households and the scale of reduction in headline inflation, I do think will be in focus on the day.

We're expecting a relatively low key budget. So the scale of measures at around 10 billion pounds, which is much more moderate than what we saw in October 2024 and in November 2025

However, we do think there is scope for some, let's say, higher level announcements. For example, Prime Minister Burnham is particularly focused on devolution in the UK, decentralization. And there might be a roadmap ahead for how different mayors and different regions in the UK get to keep their portion of income tax revenues and what they might do with it in order to boost regional growth. UK does stand out as the country in G7 space that has the most centralized fiscal system. And this might start to be changed from this fiscal event onwards.

Andrew Sheets (4:12)

Okay, so now I'd like to take a step back and do a little marking to market. You know, you and I on this program a couple of different times this year have been talking about the UK and those conversations have generally been upbeat. I think both of us were of the view that the UK could actually be a bit better of a story than expected. And maybe we start with the good news. What do you think has been going right?