With the Autumn budget imminent, David Zahn, Head of European Fixed Income, Franklin Templeton Fixed Income, believes the UK government’s current fiscal approach, reversals and lack of a clear debt-reduction strategy are key issues eroding investor trust.
The UK government’s current fiscal approach reflects a troubling absence of a coherent, long-term plan. Instead of decisive structural reform, the government is opting for a series of reactive, piecemeal measures that are eroding market confidence and weakening the broader economy. The decision to sidestep substantial, structural tax reforms – such as a broader income tax rise – was a misstep. Markets initially showed signs of stabilising with the prospect of serious fiscal balancing, however, when these options were dismissed, we saw an unwelcome uptick in rates, signalling a credibility gap with investors who seek seriousness in budget management.
Instead of strategic reform, we’re witnessing a ‘nickel and dime’ strategy. This involves a multitude of smaller, often complex tax adjustments that, while cumulatively aiming for billions, fail to address the fundamental deficit. This approach not only complicates the tax system, directly contradicting stated goals of simplification, but also generates uncertainty. When the government targets seemingly trivial areas like milkshakes or the bicycle-to-work scheme for marginal savings (e.g., 40 million against a 40-50 billion deficit), it signals a lack of strategic focus and creates an environment where investors and consumers are left guessing what minor levy will come next. This uncertainty inevitably leads to a pullback in spending and investment, as economic actors prefer stability.
Crucially, this reactive taxation strategy has already contributed to UK inflation. Past tax hikes, particularly on minimum wage and National Insurance, have been identified as significant drivers of current UK inflation. If similar inflationary measures, such as increased National Insurance on pension contributions, are pursued, they will further constrain the Bank of England’s ability to cut rates. While the economy desperately needs lower rates, persistent inflation prevents the necessary monetary easing, leaving the UK in a difficult economic bind.
Adding to the challenge is the absence of any meaningful spending cuts. With public spending continuing its upward trajectory, the government finds itself in a perpetual cycle of seeking new tax revenues each year, a pattern that undermines any perception of fiscal rigor in the bond market. This cycle risks reaching a point of diminishing returns, where over-taxation disincentivises work, drives talent abroad, and worsens welfare challenges. The massive liability of public pensions, another critical area needing reform, also remains untouched, despite clear avenues for adjustment.
Constant reversals and the lack of a clear debt-reduction strategy further erode trust. Unlike EU peers with ECB support, the UK lacks a robust backstop, leaving its fiscal position exposed. The current trajectory suggests continued instability, repeated and potentially inflationary tax demands, and a bond market that will remain deeply skeptical until a truly credible, long-term plan for both revenue and expenditure emerges. Without fundamental reform, the UK risks being trapped in a cycle of fiscal short-termism with significant long-term economic consequences.
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