The rock is slowing growth, the hard place is dwindling fiscal headroom, and this government is sitting right in the middle!
In her Spring Statement on Wednesday, Chancellor Rachel Reeves unveiled a £14 billion plan to address the UK’s public finances and the challenges of declining economic growth. Amid growing concerns over her shrinking fiscal headroom and the introduction of tax hikes like National Insurance and inheritance tax increases, there were fears that even harsher measures were on the horizon. While Reeves managed to avoid the worst-case scenarios, she still presented a cautious outlook on government spending and the broader economic situation.
In line with the government's manifesto promises, there was no increase in income taxes or extension of threshold freezes. Instead, the focus shifted to spending cuts aimed at restoring fiscal headroom. With the Office for Budget Responsibility (OBR) forecasting a bleaker economic outlook and higher borrowing costs than previously expected, the Chancellor was forced to tighten fiscal policy to maintain her £9.9bn fiscal buffer. According to OBR modeling, welfare cuts are expected to save £3.4bn.
Regarding departmental budgets, which set spending limits until 2030, Reeves stated her goal of making the state ‘leaner and more agile’. She also confirmed the introduction of a voluntary redundancy scheme for civil servants, expected to deliver £3.5bn in ‘day-to-day savings by 2029-30'. Government spending is now projected to grow by an average of 1.2% per year above inflation, slightly lower than the previous 1.3%.
The OBR’s downgraded economic growth outlook paints a challenging picture, with the UK's fiscal position remaining precarious in the coming years. While the 2025/26 financing requirement aligns with expectations, borrowing levels for subsequent years are still high. However, the immediate market reaction was relatively positive, as the news was seen as less severe than anticipated. The OBR forecasts growth of 1% in 2025, 1.9% in 2026, 1.8% in 2027, 1.7% in 2028, and 1.8% in 2029.
The statement wasn’t solely about cuts; as expected, the Chancellor committed to increasing the Ministry of Defence’s (MoD) budget by £2.2bn for the next financial year, with an additional £6.4bn by 2027. The aim is to transform the UK into a ‘defence-industrial superpower,’ giving British defence companies greater opportunities to make, buy and sell in the UK as well as further opportunities to grow and create jobs as military spending rightly increases across Europe.
In the aftermath of Reeves’s speech, UK markets and the pound have remained stable. The Chancellor has avoided a deeper bond sell off but there may be difficult decisions looming for her and the rest of the government in the Autumn at the next budget in relation to personal tax increases.
The Spring Statement was delivered in a difficult market environment, with the UK’s downgraded growth forecast occurring against a backdrop of stock market volatility. After more than a decade of strong growth, US stock prices have fallen this year, while European shares have shown resilience. While the challenges presented are clear we do not believe the Chancellor’s statement requires us to make any changes to our portfolios.
Mark, Chris, Dan, Matt, Scott and Florrie
Square Mile Investment Management Team
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Date: March 2025, unless otherwise stated.