Rhythmic Reasoning_Full Report_Final_EN - Flipbook - Page 29
THE DRUMMER'S EAR | RHYTHMIC REASONING
health, general public administration, and defence—with more
coming in line with pledges in the 2025 Spring Statement.
(and with a lower initial threshold to require these contributions)
have added fuel to the fire of already strong growth in labour costs.
The Labour government’s spending boost could fall short of
objectives laid out in March, and thus dampen U.K. GDP growth
prospects, as Chancellor Reeves fails to sufficiently clean public
finances, possibly requiring one of, or both, of belt tightening
or higher taxes upon the late-November Budget announcement.
Gilt yields at 4.75% and 5.55% at 10-yr and 30-yr maturities
respectively, sit decently above 4.15% and 4.75% yields in the
U.S. and around two percentage points higher than comparable
German maturities at 2.75% and 3.35% (even with Germany’s
newfound appetite for public spending).
Fig. 3: Starmer government faces high disapproval ratings
Fig. 2: Rising deficit challenges fiscal expansion plans
% polled, approve/disapprove the
government's record to date
60%
40%
20%
0%
2011
2013
Approve
16%
Budget deficit, 4qtr avg, % of GDP
80%
2015
2017
Disapprove
2019
2021
2023
2025
Don't know
Source: YouGov, Scotia Wealth Management
12%
8%
4%
0%
2018
2019
2020
2021
2022
2023
2024
2025
Source: ONS, HM Treasury, Scotia Wealth Management
U.K. yields reflect serious market concerns over the U.K.’s fiscal
path, with the wound deepened by the BoE’s need to keep rates
elevated (and continue Quantitative Tightening), thus lengthening
the high interest burden faced by HM Treasury. As of 2Q25, the
four-quarter deficit averaged 5.4% of GDP (Fig. 2), an increase from
4.9% in 4Q24, to sit at its highest point since 2021 and very far
from 1.9% of GDP in 4Q19 just ahead of the pandemic. The central
government’s interest bill has also climbed to 3.1% of GDP in the
year to 2Q25 which—while lower than the 4.1% peak in 2022—
represents a significant increase from 2.1% at end-2019 and limits
the government’s capacity to spend on public infrastructure or
services, depressing the U.K.’s long-run growth potential.
With ~70% of Britons disapproving of the Starmer government
(Fig. 3), on par with disapproval rates at the end of Sunak’s PMship,
Chancellor Reeves is unlikely to announce significant revenueraising measures (read, taxes) to mend public finances. Instead,
they may be pressed to go back on some of their spending
promises, a less unpopular (yet GDP-negative) decision. For now,
our projections assume spending in line with the Spring Statement,
but the November Budget could shave up to a few decimal points
off GDP growth forecasts for 2026.
Amid higher employer costs and economic uncertainty, U.K.
payrolls have contracted for seven consecutive months (and
eleven of the past thirteen months, Fig. 1), with around 150k
positions lost since the October 2024 peak. When excluding public
administration, health, education, and social work headcounts,
U.K. payrolls have contracted by 300k from their May 2024
highs, reflecting the outsized contribution of greater public sector
momentum against weakness in the private sector.
At its mid-September rate hold announcement, the BoE
highlighted that it anticipates a significant slowdown in pay
growth as labour market slack builds due to depressed labour
demand, but soft economic conditions continue to clash with price
pressures. According to the BoE, “upside risks around mediumterm inflationary pressures remain prominent.” In August, headline
inflation sat at 3.8%, up from 2.5% at end-2024, while core inflation
printed at 3.6%, remaining in a 3.5-4.0% zone since the start of the
year—with services sitting near 5% (Fig. 4).
The timing of the next BoE rate cut remains highly uncertain but,
as things currently stand with regards to the latest BoE guidance
and upside inflationary risks, the next rate reduction seems unlikely
to come at the November decision when the BoE will also update
its macroeconomic projections. The U.K. Budget scheduled for
November 26th will likely complicate the BoE’s certainty over its
growth and inflation expectations presented earlier in the month.
The next rate cut may come at the final meeting of 2025, in
December, but regardless of when this occurs, we expect only small
rate cuts support for the economy as the BoE sticks to a gradual,
quarterly, pace of rate easing.
Policy decisions are also having a clear negative impact on U.K.
labour markets and inflation. A large ~7% hike to the minimum
wage in April 2025—compared to a 2.4% average inflation rate in
April 2024-March 2025—and a mandated increase in employer
pension contributions from 13.8% to 15% of employee earnings
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