Six ways the UK’s Autumn Budget could send bond yields spiking

Let’s cut to the chase: UK Chancellor Rachel Reeves faces a fiscal hole in the region of £25bn to fill this autumn.

That’s relative to the fiscal position back in March and is likely to be a casualty of weaker productivity growth forecasts (slower economic growth equals lower tax revenues), higher gilt yields (lifting debt interest projections) and policy U-turns.

Strictly speaking, the Treasury only has to find £15bn of that. Recall that the chancellor had £10bn in headroom (explained in more detail below) in March, offering a very small buffer against this sort of adverse forecast revision.

That wouldn’t be a great look, of course. Most chancellors have preferred to leave much more than £10bn/year in reserve, precisely to avoid the sort of situation Reeves finds herself in now. That is, raising taxes simply because the economic projections have soured. The Treasury is now under pressure to leave a bigger error margin than it did in the spring.

If it did, it’s tempting to say that government bond (gilt) yields would fall. Ten-year yields have fallen back this month, but remain highly sensitive to borrowing news.

Yet that logic isn’t necessarily true. We don't think the rules themselves matter all that much to markets. It’s what’s going on beneath the surface. A lower amount of headroom, but backed by clear, upfront revenue raisers or spending cuts, would likely be favoured over more headroom that’s achieved only by dubious promises about tax and spending later this decade.

The message so far is that the details of the budget matter more than whether the fiscal rules are met on paper.

On spending, cuts look near-impossible. The political backlash to scrapping Winter Fuel Payments and tightening welfare made that clear. The initial savings were never huge, and the policies have since been reversed. Reports indicate the Treasury hopes to try again, but gains will likely be minimal.

The real test is departmental budgets. After a 4% real-terms rise this year, increases slow to 1.9% in FY2026 and just 1% annually thereafter. With population growth, many “unprotected” areas face real-terms cuts.

Pressure to boost these plans will be intense – politically and practically – as public services remain stretched.

Markets will be watching. A 3% real-terms uplift next year (vs. 2% planned) would cost around £5bn and raise borrowing. That’s manageable, but it risks signalling weak future restraint, especially if offset by shaky promises of austerity later. Investors know such pledges rarely hold.

There are two key questions on tax hikes: do they kick in straight away (or at least in April)? And do they raise a predictable amount of revenue?

A substantial portion of last autumn's tax hikes were implemented this year, raising an extra £24bn, rising to £41bn by the end of the decade, according to Treasury analysis at the time. We suspect markets would like to see a similar degree of front-loading this time.

The government faces a choice. Break its election promises and raise income tax, employee NI or VAT. Politically challenging, but where small changes can raise big and predictable sums. The employer NI hike in April is raising almost exactly what the OBR predicted it would – and if anything, a little more.

Alternatively, it could focus on minor taxes, which often require substantial changes to generate meaningful revenue due to their limited scope. The revenue is unsurprisingly more unpredictable; "other taxes" have raised £4bn less than the OBR expected in the first five months of the fiscal year.

Press reports suggest this budget will land somewhere in the middle, where the emphasis is on targeting tax on asset returns and wealthier individuals. Widening the scope of National Insurance to include landlords, partnerships and pensioners in work could raise up to £5bn. An increase in the corporation tax surcharge for banks also looks likely, as does an increase in dividend taxes. Changes to the way pensions are taxed – be it contributions or payments – are also possible.

The government will almost certainly also extend the tax threshold freeze beyond 2028, a move which will raise up to £10bn/year by the end of the decade, but makes zero difference to borrowing next year.

If this is the plan, then we think it's one that investors will largely tolerate. Yes, the changes are controversial. Yes, they do focus heavily on minor taxes, and yes, there is a bit of creative accounting. But we would expect the OBR to judge that a material amount of extra revenue would still come in 2026. Importantly, there appears to be less of a hit to businesses at a vulnerable moment in the economic outlook.

More broadly, a budget that focuses on tax hikes will be viewed as more credible than one that leans on spending, simply because the former is less likely to be walked back upon in the future.

If spending doesn't rise any faster and tax hikes yield significant sums early on, then investors can expect a material fall in gilt issuance next year. We don't think it's fully appreciated that the budget deficit is set to fall noticeably in 2026.

Public sector net borrowing is on track to hit 4.2% of GDP this year (a bit above the OBR’s 3.9% forecast from March). Current OBR forecasts have that falling to 3.1% in 2026/28, and barring any surprises, we don't expect that to change enormously.

The fall is driven predominantly by the ongoing freeze in tax brackets. Income tax as a share of GDP is set to rise.

Even if spending rises more quickly than planned – let’s take that scenario of departmental budgets rising 3% not 2% in real terms – the deficit impact is a relatively minor 0.2pp of GDP. That’s not enough to derail the overall fall in net borrowing as a share of GDP.

The Debt Management Office already foresees the gilt remit – gross issuance – falling from £299bn (closer to £310bn in practice, given the borrowing overshoot) to £270bn next year.

The risk though is that the budget results in another year of circa £300bn gilt issuance. That would be an issue for bond markets. But if recent reporting is broadly accurate on the Treasury's plans, we think gilt yields are more likely to fall than rise after November's budget.

Another factor arguing in favour of lower gilt yields is the Bank of England outlook. The overriding reason why 10-year yields are so high is that markets expect the Bank of England to keep rates above 3.5% well into the future.

The Bank itself is becoming more reticent to lower rates, at a time when headline inflation is around 4%. More than ever, officials are focused on current levels of inflation – particularly food – out of concern that this will fuel inflation expectations and keep headline CPI above target for a long time. We’ve long felt these concerns are overblown at a time when the jobs market is cooling and wage growth is visibly easing.

Still, inflation is elevated in part because of tax rises and regulatory price increases linked to last year’s budget. Higher National Insurance and a sharp increase in the National Living Wage help explain the spike in food inflation, which has risen well above the eurozone. The Bank of England won’t take kindly to further tax hikes that, directly or indirectly, add to inflation rates. Even if, in the longer term, all tax increases tend to pull down on inflation via weaker economic growth. The most obvious examples are VAT and fuel/alcohol/tobacco duties.

The Treasury appears to be well aware of this risk and is openly talking about measures to curb inflation in 2026. Its ability to do this is limited, but is likely to centre around cuts to VAT on domestic energy bills.

Last year, the rise in gilt yields around the budget was driven primarily by rising short-term BoE expectations, on the OBR's prediction that the budget would boost growth and inflation. The OBR said back then that it had lifted the Bank Rate profile underlying its economic forecasts by 25bp to compensate. This time, we'd expect to see the exact opposite, adding downside potential in gilt yields at a time when very little is priced in for further rate cuts.

We think the biggest risk for UK bonds in the Autumn Budget is a change to fiscal rules. It’s the easiest way of avoiding raising tens of billions of pounds in extra taxes. And the rules are set to change next year anyway; rather than requiring a current budget surplus in 2029/30, the Treasury will be allowed to run a small 0.5%/GDP deficit. That will open up an extra £17bn/year of spending power.

Bringing that forward to this autumn may sound innocuous, but it would likely go hand-in-hand with a material increase in borrowing next year, relative to prior forecasts. We think it would provoke a material rise in gilt yields.

We had a taste of this back in early July, when longer-dated yields briefly spiked on speculation about Reeves being replaced. The chain of logic appeared to be that a new chancellor would almost certainly relax the fiscal rules, opening the door to more borrowing and bond issuance.

Judging by recent press reports, rule changes in this budget are unlikely. Yet political pressure on Starmer and Reeves is mounting. Were that pressure to ramp up, particularly into next May’s local elections, with investors weighing the possibility of a leadership challenge from the left of the Labour Party, this could put renewed upward pressure on gilt yields.