No drama, some fiction: What's going to be in the UK Budget?

The Chancellor, John Healey, delivers his first Budget on Wednesday, 28 October. Here we try and break down all the key things to understand about the fiscal set piece and what it could mean for the next 12 months for UK assets.

Key points

• The Budget this year is a precursor to an early election in 2027 - expect a steady-as-she-goes event with limited tax hikes as the Chancellor kicks (nearly) all the big decisions into 2027

• The fiscal position could be stronger than indicated by reports that have been focused on higher bond yields, with better wage growth and productivity gains the 'secret sauce' to unlock billions in extra headroom. The OBR numbers are a crucial unknown at this stage

• Watch for changes to thresholds and national living wage adjustments, and defence spending to rise

Toned-down Budget = Early Election in 2027

It seems clear that everything is pointing towards an early election in 2027. This explains why the Budget this year is looking so toned-down relative to Labour's big ambitions. Anything other than a 'steady-as-she-goes' event would be a surprise and arguably this means there is a low bar for an unfavourable market reaction.

I don't think, however, that this is likely with 'safe-hands' Healey. The runup to the event has been very tightly controlled. We know that Andy Burnham has a vision and a 10-year plan, but less than three years left of this parliament. We know he plans to end the pension triple lock and roll out a national care service modelled on the NHS. Then there is nationalisation plans. These are big commitments – why not get on with them at this Budget? Add in a pivot to the EU and talk of even rejoining now doing the rounds, and it's clear that an election is coming early in 2027.

Moreover, polling data is heading Labour's way and Burnham has got lucky with the resilience in the UK economy. It seems the PM wants to get the Budget out of the way, deliver his ten-year plan, ride the Burnham Bounce into an election and win a mandate to tax and spend, and even rejoin the EU. The government also wants to delay its Spending Review, where it painfully allocates departmental budgets, until next autumn. This only really makes sense if you are planning an election.

Kicking big decisions down the road is not unique to the Burnham government. However, I think in this case the political backdrop and Burnham’s own agenda mean doing so tomorrow is less about political expediency and clinging to credibility than it is about laying the pathway to an early election next year to deliver the mandate and flexibility on taxation he seeks to carry out more radical reforms. My view is everything points towards an election next year. Betting markets don't reflect this, and I think markets are under-pricing election risks, but over-pricing near-term fiscal risks.

Fiscal Headroom: Higher than it Looks?

The market assumes the headroom of £24bn left by Rachel Reeves has been roughly halved. I think the fiscal position may be better than indicated by reports that have been focused on higher bond yields, with wage growth and productivity gains (the 'secret sauce') to unlock billions in extra headroom. The OBR numbers are a crucial unknown at this stage. A headroom figure below £15bn probably gets punished by bond markets by increasing UK fiscal risk premia.

The starting point for UK productivity is better than official data has been telling us. The OBR said in March that it sees potential output growth of 1.5% over the medium term, but the composition of growth tilting back to productivity, rising to 1% by the end of the forecast. Since then, changes to the way the ONS looks at the data has seen UK productivity growth revised higher. Coupled with emerging signs of an AI-led improvement in productivity growth suggests the forecasts could be rosier in this Budget. Annual productivity growth expanded almost 2.4% between the third quarter of 2024 and the first three months of 2026, while output per hour rose by 1.4% in the year to June, meaning the starting point is higher than it was in March, which could see the OBR revise up its forecasts for productivity growth. Why does this matter? The OBR assumed 1% growth but noted in March that if productivity growth was 1.5% a year over the forecast, for example, borrowing could be £50 billion lower in 2030-31.

Wage growth assumptions in the OBR forecasts have also been a bit lowball, forecast at 2.2%, while the Bank of England sees wage growth at 3.1% and recent numbers have consistently beaten the OBR number. Pay in the year to April rose 5.7% for full-time employees. A higher productivity multiplier and a more sensible wage growth forecastcould actually see headroom increase, more than offsetting the hit from higher bond yields.

Healey will also likely follow his predecessor in backloading spending cuts that he has no intention of making and tax hikes to the end of the assessment period, balancing the books with a sleight of hand. The IFS points out that “pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction”. That may be so, but the market might prefer it to Truss-like drama.

Improved economic forecasts and a better-than-expected fiscal outlook could bring gilt yields down after the Budget - the repair job will be better than expected. However as stated above, the market may be short a more radical Labour manifesto combined with the inherent uncertainty from a snap election.

A solid headroom repair job - £20bn-24bn or above - gets gilt yields down on the day, even if the Budget looks rather backloaded with real terms departmental spending cuts in the last two years of the parliament that Healey never intends to carry out. The market can probably overlook it, though, especially if there is an election on the way.

The key question afterwards will be how the Budget moves market expectations for an election to be called.

D-Day or Delay for Defence?

We had assumed that the decision on accepting a timeline to reach spending 3% of GDP would be delayed until next year’s Budget. This was always going to be a sticky one for Healey, since he resigned from the Starmer government on this issue.

On the equities side, reports the government would delay its decision on increasing defence spending to 3% of GDP has weighed on the sector. However, I noted that a clear commitment in the Budget to cover the existing £4.7bn shortfall in the government’s defence investment plan would likely be seen as a positive catalyst.

Since then, Burnham has stated that the Budget would set out a path for defence spending to hit 3% of national income by 2030. This would imply significant extra spending, with implications for the fiscal headroom within the OBR forecasts. 

For UK-listed defence names such as BAE Systems, Rolls-Royce, Babcock and QinetiQ, the key issue is not whether defence spending rises over the long term, but whether the government commits real money quickly enough to close the £4.7bn DIP shortfall; accelerate progress towards 3% of GDP; and bring procurement forward rather than backloading expenditure. There is a danger that the Budget contains only a pathway to increased spending rather than committed funds.

What Could be in the Budget?

Bank tax: After years of bumper profits the banks are looking like soft targets to raise revenue. The Chancellor could raise the 3% surcharge on profits or it could raise the bank levy, which is based on the size of their balance sheets. Returning the surcharge to 8%, where it was before the last Conservative government reduced it, is not out of the question. Although we should note that today’s higher rate of corporation tax (up from 19% to 25% in 2023) means a rise to 5-6% is more likely. This would take the combined corporate tax burden to 31%.

Housing: The government has already announced its revival of the Help to Buy scheme. Healey could make it more generous by raising household income eligibility limits, effectively expanding the scope of the scheme to reach significantly more first-time buyers. In addition, I would expect some accompanying supply-side announcements, although these are likely to be limited. Watch for a move on Land Remediation Relief to speed up brownfield developments. The Treasury explicitly says it intends to set out its conclusions at Budget 2026. This is an identified policy catalyst.  The government has already pre-announced that an additional £1bn for social and affordable housing in England will be provided in the Budget.

Capital Gains Tax: The Chancellor has reportedly rejected calls to raise CGT rates again, after Rachel Reeves pulled this lever last time.BADR: One option is to remove the lower rate on Business Asset Disposal Relief to simply tax it in line with the higher and additional rate of 24%. The £1m lifetime limit on gains that can qualify for BADR could be also reduced. Before the 2024 Budget the Institute for Fiscal Studies estimated that abolishing BADR would raise about £1.5bn in additional revenue. The downside to this approach is that would fall disproportionately on smaller businesses, which would hurt growth. Therefore,I think it seems an unlikely target given the Chancellor's rhetoric on small businesses and business rates relief. There may be changes to capital gains rebasing when assets are gained at death, though again I think this may wait until there is a more comprehensive review of the Inheritance Tax regime.

NI: The Chancellor may seek to broaden tax base for National Insurance to landlords and partners in LLPs, which could raise around £2bn a year.

Mansion tax: No cut to £1.5mn. Healey has ruled out cutting the ‘mansion tax’ threshold from £2mn to £1.5mn. The levy, first announced by Rachel Reeves last year, will begin in April 2028 and will require homeowners to pay anything from £2,500 a year up to £7,500 for the most expensive properties valued at over £5mn.Online retailer tax: A crackdown on mainly foreign online sellers is expected to raise around £1bn by making marketplaces like Amazon and eBay responsible for collecting VAT upfront. It’s expected this will used to offset plans to raise the threshold for business rates to exclude around 140,000 small high street shops from business rate, which is expected to cost about £900mn.

Pension tax relief: Healey is expected to raise the tax-free allowance for low-income pensioners to £13,036 to shield the state pension from income tax.

Gambling tax:Reports suggest the Chancellor will only raise the machine games duty 5% rather than 20% being called for by Labour MPs. The big bookies are still absorbing the impact of an increase in remote gaming duty from 21 per cent to 40 per cent, whilst there is also a new 25% rate of general betting duty for online bets from April next year, up from 15%. High uncertainty over future tax rises mean I think this remains tough to super optimistic on this sector. We had a bit more on some sector specific impacts here.

National minimum wage: Expected to rise about 4%, but slower for young people.

Energy bills: Targeted support for lower income households is a done deal.  

Surprise, surprise?

Dividend Tax regime: Alignment with income tax would be a big blow for equity investors but I think unlikely. But they could be raised again after Reeves hiked last year. Currently, these are taxed at: Basic Rate Band 10.75% (increased from 8.75%), Higher Rate Band: 35.75% (increased from 33.75%), Additional Rate Band: 39.35% (unchanged). Watch if the £500 allowance is scrapped. On the equities side this represents a significant risk, particularly for asset managers, insurers and dividend stocks.

Changes to pensions and tax-free cash: Thankfully this year there has not been the same rumours about pension tax relief, which prompted many people to sell down holdings before the Budget only for there to be no reduction in relief. Nevertheless, possible measures include restrictions on pension tax relief, employer contributions or the tax-free lump sum. These would affect long-term savings flows and could be negative for life insurers, asset managers and investment platforms. A major overhaul of pension tax relief, such as flattening the top rates to 20% or reducing the tax-free lump sum people can take from their pension, would have broad UK equity market impact.

Tax switch – a novel idea put forward by a think tank or two suggests raising income tax +2ppt, lowering NI –2ptt. It broadens the tax base and is worth £6bn, but it would yet another blow to pensioners after they've already been told the triple lock will end under Labour.

And the Rabbit?

Raising income tax thresholds would be extremely expensive but a potential rabbit in the hat, which they may think worth a go, especially if there is enough additional headroom to plug the defence gap.

The Conservatives will call it a work of fiction, but the market may be happy if Healey leaves the true-life drama on the shelf.