“Central to the Budget was the decision to lower the fiscal headroom to a very thin £15bn, down from an already relatively low £23.6bn by historical standards in March. While it was right for the Chancellor to try to avoid fine-tuning policy in response to every change in the economic outlook, leaving such a narrow margin against his fiscal target risks forcing him to do exactly that at the next budget.
“Much of the fall in headroom was driven by higher long-term government bond yields, while debt interest payments as a share of national income have more than doubled since the pandemic. In this environment, the credibility of the Chancellor’s plans is particularly important. While the immediate reaction from financial markets was muted, the Chancellor will remain constrained by how far the size of the debt has risen.
“The indicative public spending envelope implies cuts to day-to-day spending for non-protected departments. This is in the context of higher-than-expected public sector pay settlements and inflation, which will add pressure on departmental finances.
“With much of the fiscal consolidation required to balance the current budget materialising in the final years of the forecast, there are questions over how durable this approach will prove. Tax receipts as a share of GDP are already the highest since records began in 1948, raising doubts about the scope to increase them much further. This is compounded by the fact that 2029-30 is an election year, creating further uncertainty over whether the planned fiscal consolidation will ultimately be delivered.
“Capital spending was increased, with additional investment directed towards defence, AI and digital, and clean energy. The increase in capital spending is welcome, but it is not without fiscal risks. The Chancellor has used the flexibility within his second fiscal rule to increase capital spending, leaving net financial liabilities little changed. However, this will increase borrowing from 2028-29 onwards, adding to already-high debt interest costs.
“The eye-catching measures to ease the cost of living and help for small businesses will attract headlines but are relatively small in scale. Support for household energy bills, including a direct payment of £100 to around 20 million households and the VAT cut on electricity until July, is more targeted and modest compared with the size of the energy price shock than previous support packages. The additional support was paid for by higher taxes on banks and the gambling sector, with no major tax or spending surprises elsewhere. The Chancellor also managed to limit the leaks and speculation in the run up to the Budget, helping to minimise the dampening effect on economic activity.”
