United Kingdom: Risks for Sterling – ING

ING’s economists describe United Kingdom (UK) public finances as strained by rising spending pressures and high debt interest, despite ongoing fiscal consolidation via frozen tax thresholds and falling gilt issuance. They warn that potential policy shifts under Prime Minister Burnham, including changes to fiscal rules or tax allowances, could unsettle investors and re-focus attention on UK fiscal risks into the autumn budget.

Consolidation now, questions later

"Like much of Europe, there are plenty of reasons to be downbeat about the UK’s public finances. Spending pressures are growing – from defence to health and social care. Debt interest costs are high and rising, not helped by Britain’s large stock of index-linked bonds and increasing reliance on foreign investors (particularly hedge funds)."

"That said, the UK is also a rare example of a country undergoing some meaningful fiscal consolidation. Since 2021, the tax thresholds have been frozen in cash terms. And subsequent waves of inflation have dragged more and more people into higher tax brackets, increasing tax revenues as a share of GDP."

"Over recent weeks, investors had become more relaxed about Burnham’s appointment, following his commitment to stick to the existing fiscal rules. In theory, that precludes a stimulus package this autumn that would either materially increase gilt issuance or change the calculus for the BoE."

"But Burnham’s recent openness to bigger changes – including lifting the tax-free allowance and greater funding for social care – means a bolder budget can’t be ruled out. Investors will be particularly sensitive to any headlines on tweaks to the fiscal rules in the run-up to Burnham’s first budget this October or November."