Pound Sterling and Gilts Steady as Markets Take Tax Hikes and Spending

Chancellor Rachel Reeves delivers the Autumn Budget 2024. Picture by Lauren Hurley / DESNZ.

The British Pound fell below key levels against the Euro and Dollar as the Chancellor of the Exchequer, Rachel Reeves, delivered the 2024 budget.

The Pound followed UK gilt (government bond) yields lower after Reeves said the UK budget deficit is expected to fall sharply in 2026/2027 and then move into surplus. Gilt yields fell on the news.

"What will delight the Chancellor is the financial market reaction. There were fears that stock and bond markets would not react favourably to the announcements today and the loosening of fiscal rules. But for now, gilt yields are down and there is no sign of a repeat of the mini-budget from 2022," says Lindsay James, investment strategist at Quilter Investors.

To shrink the budget deficit in the coming years, Reeves announced tax hikes of £40BN, with the headline being a hike to the tax paid by employers when paying employee salaries.

Employer National Insurance rate was raised by 1.2 to 15% and the threshold will be cut from £9100 per annum to £5000.

"That is a £25bn tax rise, proportionally hitting harder those employing lower paid workers. Probably three quarters or so of the increase will flow through to lower pay," says Paul Johnson, Director at the Institute for Fiscal Studies.

Reeves said the Office for Budget Responsibility, which assesses the spending and tax plans, issued its new forecasts that show inflation won't fall back to the Bank of England's 2.0% target until the end of the decade.

The prospect of inflation remaining above target for the foreseeable future should ensure the Bank of England maintains a cautious approach to cutting interest rates, which can keep the Pound supported.

Nevertheless, the fall in bond yields is having the predictable effect of drawing Sterling lower in the immediate term: the Pound to Euro exchange rate is back below 1.20 at 1.1972, and the Pound to Dollar exchange rate is lower at 1.1970.

Above: GBP/EUR (top) and the yield on UK two-year gilt yields.

Inflation will be at 2.5% in 2024 and remain above the Bank of England's 2.0% target in 2025 at 2.6%.

It is predicted to fall to 2.3% in 2026, 2.1% in 2027, 2.1% in 2028 and 2.0% in 2029.

The economy is forecast to grow by 1.1% in 2024, 2.0% in 2025, 1.8% in 2026, 1.5% in 2027, 1.5% in 2028 and 1.6% in 2029.

The government confirmed it would seek to boost government investment by changing the debt rules. It will now target Public Sector Net Financial Liabilities, whereas the previous target was based on Public Sector Net Debt, excluding the Bank of England.

This simply means the government has more leeway to increase spending, with Reeves saying the additional borrowing would be spent on investments to bolster growth and not day-to-day spending.

"We will invest an additional £100bn over the next 5 years in capital spending. Only possible because of our investment rule," said Reeves.

Investment bank consensus forecasts update: The end-2024 and 2025 guide from Corpay has been released. It shows a sizeable uplift was made to the consensus forecasts for GBP/EUR. Please request a copy here.

The increase can bolster growth and analysts say this could strengthen the Pound's prospects over the medium term.

The government also announced day-to-day spending to rise by 1.5% per annum from this year; this compares to the 1.0% that the previous government had planned.

"That it still very tight indeed," says Paul Johnson, Director at the Institute for Fiscal Studies.

"We feel more is needed given the deterioration of public services after prolonged underinvestment," says Hailey Low, Associate Economist at the NIESR.