Interest rate expectations split ahead of UK budget

As ongoing consumer price inflation (CPI) pressure and climbing borrowing costs weigh on markets in the UK, the autumn budget to be announced by the government on October 28 has entered a turning point that will directly affect monetary policy expectations. While market participants price the probability of the Bank of England (BOE) delivering a 25 basis point rate hike at next week's monetary policy meeting at 99%, the expectation of a new rate hike for the December meeting remained at 47%, splitting the market.

How much has the UK's fiscal buffer narrowed?

Ahead of the budget to be announced by Treasury Minister Rachel Healey, the UK's fiscal room for maneuver has narrowed considerably. According to EY data, the safety buffer the government holds against fiscal rules fell from 23.6 billion pounds in March to 11.3 billion pounds due to rising borrowing costs and the economic repercussions of Iran-based conflicts. Surveys indicate that this buffer needs to be raised back to the 15 to 16 billion pounds band to reassure bond investors and calm the gilt market.

As part of revenue-raising measures, the government is expected to increase the tax on bank profits. In addition, lowering the luxury housing tax threshold from the current 2 million pounds to 1.5 million pounds is on the table. On the spending side, targeted energy bill support for low-income households and the extension of the fuel duty cut stand out, while large-scale spending on housing construction, defense and public services is projected to be deferred to 2027.

How will budget decisions affect the interest rate path?

Markets will closely examine the Office for Budget Responsibility (OBR) consumer price inflation (CPI), growth and borrowing forecasts to be published simultaneously with the budget. Tight fiscal discipline and measures limiting borrowing could ease gilt yields, reducing rate hike pressure on the BOE; conversely, spending stoking inflationary risks could bring a fresh rate hike back onto the agenda for December.

This content is for information purposes only and does not constitute investment advice.