Britain’s financial markets are bracing for Chancellor John Healey’s first budget on October 28, with investors closely watching whether the government can restore confidence in public
finances without resorting to widespread tax increases.
The budget comes at a challenging time for the UK economy, as rising global borrowing costs and elevated energy prices linked to the Iran war put additional pressure on government finances. Decisions on taxation, public investment and borrowing could influence everything from government bond yields and the pound to bank shares, property developers and utility companies.
For investors, the central question is whether Healey can demonstrate that the government remains committed to fiscal discipline while addressing mounting economic pressures.
“This budget is about credibility,” said Luke Hickmore, investment director for fixed income at Aberdeen Investments.
He warned that bond markets would closely scrutinise the government’s commitments. Maintaining its existing fiscal strategy could help borrowing costs decline, while unexpected measures risk triggering a swift negative reaction.
Bond market pressure leaves government with less room to manoeuvre
The UK’s public finances have come under increasing strain following a sharp sell-off in global government bonds. In October, the yield on 30-year British government bonds, known as gilts, briefly climbed above 6%, increasing the government’s borrowing costs and reducing its financial flexibility.
The government’s fiscal headroom — the amount by which it expects to meet its self-imposed borrowing rules — stood at £24 billion in March. Economists now estimate that figure has fallen to between approximately £8.5 billion and £16 billion, partly because higher interest rates have increased the cost of servicing public debt.
The reduced margin presents a significant challenge for Healey as he prepares to set out his spending and taxation plans. Investors will want evidence that the government can comply with its fiscal rules even if it avoids raising major taxes.
Despite the recent turbulence, some factors have helped stabilise market sentiment. Relative political stability, improving economic indicators and the Bank of England’s decision to pause its sales of government bonds have provided some reassurance.
Adarsh Sinha, Bank of America’s head of global G10 foreign exchange strategy, said the UK continued to face a fiscal risk premium, although its position might appear less concerning than that of some other countries.
Nevertheless, investors are likely to remain sensitive to any indication that the government’s borrowing plans could weaken confidence in its financial management.
Sterling remains resilient, but investors are wary of surprises
The pound has remained relatively firm ahead of the budget, trading near a 16-month high against the euro. Activity in foreign exchange options markets suggests investors are not treating the announcement as an immediate major threat to sterling, according to Bank of America’s Sinha.
However, the currency’s relative resilience does not eliminate the risk of a sharp reaction if the government announces unexpected measures.
Markets remain mindful of the turmoil triggered by former prime minister Liz Truss’s 2022 mini-budget, when plans for substantial tax cuts without sufficient funding triggered a sell-off in British government bonds and sterling.
Dominic Bunning, Nomura’s head of G10 foreign exchange strategy, said investors would pay particular attention to whether the government attempts to channel additional borrowing through public financial institutions.
Such an approach could raise questions about the transparency and credibility of the government’s fiscal strategy, potentially creating fresh pressure on the pound.
For currency traders, the key issue will be whether Healey’s plans reinforce confidence in the UK’s economic management or introduce new uncertainties over the country’s debt trajectory.
Banks face the prospect of higher taxes
British banks are among the sectors most exposed to possible changes in the government’s revenue-raising plans.
With limited room to increase taxes across the wider economy, financial institutions have become a potential target for measures designed to strengthen public finances. The Guardian reported on Thursday that Healey was preparing to impose additional taxes on banks in the budget.
One option under discussion is an increase in the bank profits surcharge, currently set at 3%. Analysts have suggested that the government could either restore the surcharge to its previous level of 8% or introduce a more modest increase of two to three percentage points.
The existing surcharge generates just over £1 billion annually, meaning an increase could provide additional revenue while concentrating the tax burden on the financial sector.
Investors have already shown signs of concern. Shares in HSBC, NatWest, Lloyds Banking Group and Barclays have fallen between 3% and 5% so far in October.
The declines broadly reflect weakness across European banking stocks amid rising global borrowing costs, although uncertainty surrounding the UK budget has also weighed on sentiment.
A larger-than-expected tax increase could put further pressure on bank valuations, while a more limited measure might help the government raise revenue without significantly undermining investor confidence.
Housebuilders look for support from first-time buyer measures
The UK’s housebuilding industry is hoping the budget will provide fresh momentum after a prolonged period of weak demand and affordability pressures.
Shares in housebuilders rallied in late September after the government confirmed plans for a new scheme to support first-time buyers, raising expectations that additional assistance could help revive activity in the housing market.
RBC analyst Anthony Codling described the proposed initiative as a potential catalyst for a broader recovery in the sector, suggesting it could encourage investors to reassess the prospects of British residential developers.
However, the initial optimism has since faded as higher mortgage rates have created fresh obstacles for prospective buyers. Some of the gains recorded ahead of the budget have consequently been reversed.
The effectiveness of the proposed support will depend on its final design, the number of buyers eligible and whether it can improve access to homeownership without being offset by higher financing costs.
Investors will therefore be looking for further details on the scheme and any additional measures intended to stimulate housing construction and demand.
Utilities assess the implications of government intervention
Energy and water companies are also monitoring the government’s policy direction, particularly as ministers consider ways to reduce household costs and improve infrastructure.
Prime Minister Andy Burnham intensified pressure on underperforming water companies in a major speech last month, renewing discussion about greater public ownership in parts of the sector.
He also announced plans for Great British Grid, a new publicly owned electricity networks company intended to help reduce energy costs and accelerate connections to the power grid.
The proposals have raised questions about how public-sector involvement could affect existing private infrastructure operators, their investment plans and long-term growth prospects.
JPMorgan has maintained a positive outlook on UK utilities following the recent policy announcements, arguing that the proposed Great British Grid does not represent a significant threat to electricity network companies’ growth and value-creation objectives.
The utilities sector has gained almost 4% since Burnham’s announcements, outperforming the broader British stock market, which has remained largely unchanged over the same period.
That performance suggests investors have so far been relatively comfortable with the government’s proposals, although further details on regulation, ownership and financing could influence sentiment.
A decisive test of confidence in the UK economy
Healey’s first budget will be judged not only by the measures announced but also by the extent to which they reassure investors that the government can balance its economic priorities with the need to maintain sustainable public finances.
For the bond market, the main concern is whether the government can preserve sufficient fiscal headroom and avoid a further increase in borrowing costs. Currency investors will be watching for signs of fiscal credibility, while banks and utilities face uncertainty over taxation and potential government intervention.
Housebuilders, meanwhile, are hoping that measures to assist first-time buyers will translate into stronger demand despite elevated mortgage costs.
With global financial conditions remaining difficult, the budget could have consequences well beyond Westminster. A credible package could help stabilise investor expectations and support confidence in British assets. Conversely, measures perceived as financially unsustainable or unexpectedly punitive towards businesses could increase market volatility.
The challenge for Healey is to demonstrate that the government can raise sufficient revenue, support economic growth and maintain fiscal discipline without undermining the confidence of the investors on whom the UK depends to finance its borrowing. Photo by Lauren Hurley / No 10 Downing Street, Wikimedia commons.
