UK: spring statement review

The UK bond market spares Rachel Reeves

The Spring Statement was a relatively stable affair. The spending cuts had been well flagged in advance, the 2025 OBR growth forecast was cut in line with expectations, growth further in the future was revised higher, and the biggest sweetener for the bond market was news from the Debt Management Office that debt issuance plans for  2025- 2026 was lower than forecast at £299bn of gilts, better than the £302bn that was expected by the market.

Reduced debt issuance plan is welcomed by the Gilt market

The bulk of the sales are skewed towards the short end of the curve, which is also a sign that the government’s borrowing needs could moderate as we move through this parliament.  This has helped to take the pressure off the Gilt market, the 10-year yield is roughly flat on the day, after initially climbing when Rachel Reeves started to speak, the 2-year yield is also flat and is back below the highs of the day.

Growth: the OBR lowers the bar for 2025 before raising it

The growth forecasts are worth noting in greater detail. The  OBR cut their growth forecast for this year to 1% from 2%, this is well below the OECD’s growth forecast for the UK for this year, which is 1.4%. This means that the OBR has lowered the bar for UK growth this year, which could reflect well on the government if the UK economy picks up in the coming quarters.

The OBR is usually over-optimistic on UK growth, which is one of the reasons why its 2025 growth forecast was cut: the forecast was unrealistic to begin with. However, growth forecasts further out into the future were as optimistic as ever, the OBR expects growth in 2026 to rise to 1.9%, which a big jump in one year. However, if the economy does not pick up in Q2, then the 2026 GDP forecast could be on the chopping block by the time of the Autumn budget.

Rachel Reeves gets away with building fiscal headroom, for now

Rachel Reeves may have achieved her immediate goal of maintaining fiscal headroom in  today’s statement, but even the OBR has highlighted how quickly it could disappear once more. The OBR said that if the BOE base rate was to rise by 0.6% then the chancellor’s fiscal headroom would effectively be eliminated. Thus, even though Reeves has managed to rebuild her fiscal headroom, it leaves her hostage to events outside of her control, yet again. If this fiscal headroom is eroded, will the chancellor be able to cut spending once again, or will tax rises be on the horizon?

BOE rate cut outlook unchanged

The outlook for interest rate cuts are also stable in the aftermath of the spring statement. The probability of a rate cut in May has increased to 75% from 61% on Tuesday. There has also been a slight reduction in expectations for interest rates at the end of this year, but ultimately the interest rate futures market is still expecting less than two rate cuts for 2025.

Defense spending boost confirmed, as sobering message for business delivered by OBR  

The increase in defense spending to 2.5% of GDP was confirmed, and this should continue to boost the fortunes of the UK’s biggest and most high-tech defense firms including Rolls Royce and BAE Systems. These two firms are already some of the best performing on the FTSE 100 so far this year, RR is higher by 40% and BAE is higher by 36%. However, the OBR delivered a sobering message for business. The OBR expects corporate profits as a share of GDP to fall this year to 14.3% from 16.2% in 2019, due to the impact of higher wage costs and the increase in employers’ national insurance. This is one reason why UK stocks are only modestly higher on Wednesday.

GBP outlook

The pound fell leading up to the spring statement, although it has picked up from the lows of the day it is below the $1.29 level. The pound is the second weakest performer in the G10 FX space so far today, which suggests that the reduced growth forecasts has had a dampening impact on the pound, which may struggle to get above the key $1.30 level in the short term.

Overall, the spring statement passed without too much drama in financial markets. The devil is always in the detail, and some of the detail in the statement and the growth forecasts make for uncomfortable reading. The UK is not out of the woods yet, but it could, finally, be moving in a slightly better direction with a degree of stability in the public finances and a low bar for growth this year.