UK Budget Due Today: Healey Has Roughly Half Reeves' Headroom as Gilt Yields Stay Historically High

Chancellor John Healey stands up in the House of Commons today, Oct. 28, to deliver his first budget. He walks in with less money than the last person in the job and a bond market that has already shown how much it can punish governments.

Healey took the job in July, when Andy Burnham became prime minister. He is in roughly his 14th week in post.

The headroom problem

At the spring statement, predecessor Rachel Reeves left herself £23.6bn of headroom against the fiscal rules. Those rules require day-to-day spending to be matched by receipts by the end of this parliament.

That cushion has shrunk. The Resolution Foundation estimates it has roughly halved to about £12bn. Morgan Stanley strategist Fabio Bassanin says the market consensus assumes headroom restored to around £15bn.

The cause is borrowing costs. The Iran war has pushed up oil and gas prices and set off a global inflation shock. UK inflation has hit a near one-year high of 3.5% and is expected to climb further, and the Bank of England is expected to raise rates soon. Every rate rise adds to the government's own debt-service bill.

The exchequer already pays more than £110bn a year in interest, according to City A.M.

The official number comes from the Office for Budget Responsibility, which will weigh the debt-cost hit against inflation, pay growth, employment and productivity. The Guardian reports that at least £14bn is thought to be needed to avoid spooking bond investors. That is a market estimate, not a rule.

What the bond market has already done

The 10-year gilt yield reached 5.5267% on Oct. 8, the highest level since July 2007. It had eased to 5.34% on Monday, Oct. 26. Sterling hit a roughly 17-month high against the euro on Friday, then slipped Monday to 83.98 pence per euro and $1.3348.

Bassanin said expectations are now built around "limited policy action, adherence to the fiscal rules, fiscal headroom restored to around £15bn and a reduction in long-dated gilt issuance." He added: "With expectations increasingly positive, the risk of disappointment has also risen."

Roger Lee, head of equity strategy at Cavendish, put it more bluntly: "The market is very tense. It's febrile. The public finances are such that… the scope for additional borrowing – certainly at any sort of reasonable rate – is virtually none."

France is the cautionary example. Matthew Amis, investment director at Aberdeen Investments, said: "International investors are very quick to punish countries with a weak fiscal story. Just ask France." He also said a "dull budget" could be rewarded with lower borrowing costs, which would eventually free money for schools, hospitals and defence.

What Healey is expected to do

Healey has promised families and businesses "some breathing space" from the cost of living. Petrol and diesel prices are near record highs. The Guardian reports typical household energy bills are forecast to rise to £2,000 a year from January.

The chancellor is thought to have earmarked more than £1bn for energy consumers, mostly by increasing the discount on certain benefits. He has also been urged to extend a cut in fuel duty.

On revenue, a higher surcharge on bank profits is anticipated, and higher taxes on the gambling sector are possible. City A.M. reports Healey has promised not to raise income tax, national insurance or VAT.

Burnham has also pledged a new mortgage scheme for first-time buyers, more social homes, and "good growth in every postcode," with more money and power for local leaders.

Pressure from his own side

Not everyone wants a quiet budget. City A.M. describes backbench MPs and defence hawks pressing for more public spending. Burnham himself has made pledges on homelessness, elderly care and meeting NATO defence-spending targets.

None of that is free. With roughly £12bn to £15bn of room and a £110bn annual interest bill, each new commitment competes with the cushion that investors say they want to see.

Global calendar

The budget lands in a crowded week. The Federal Reserve is also due to announce a decision today, and Brown Brothers Harriman expects it to hold the federal funds target range at 3.75% to 4.00%. The European Central Bank is expected to hold its deposit rate at 2.50% on Thursday, and Citi expects French bond volatility to dominate Christine Lagarde's press conference.

The first number to watch is the OBR's headroom estimate. If it comes in near or above the £14bn that bond investors are thought to want, a quiet budget may hold gilts steady. If it comes in near £12bn, Healey's plan to hand out relief while keeping the fiscal rules intact will face its first test in the market.