What might the Budget hold?

Since last autumn’s Budget, things have taken a turn for the worse for Chancellor Rachel Reeves. While economic growth has slightly outperformed expectations in 2025 - with GDP rising 0.7% in the first quarter and 0.3% in the second - the broader picture is far from reassuring. The jobs market is softening, with rising unemployment and falling vacancies, and inflation remains stubbornly high, which is limiting the Bank of England’s ability to cut interest rates and support the economy.

Productivity continues to lag, and the UK still faces some of the highest energy prices in the world — a drag on both business activity and household spending. All this comes as the government spends more than it earns and attempts to rein in the welfare bill to help balance the books were quashed. The result? Another fiscal “black hole” reportedly to the tune of £40bn — and little sign of the kind of growth needed to fill it.

Reeves Budget 2.0

The Chancellor’s first Budget included some long-term growth measures, such as increased public investment and looser planning rules, which could pay off over time. But several short-term policies have drawn criticism. Increases to the minimum wage and employers’ National Insurance contributions have dented business confidence and hiring. Meanwhile, changes to tax reliefs — particularly those affecting small businesses and farms — have sparked widespread concern.

Further tax hikes could risk choking growth even more. Yet with Labour MPs largely opposed to spending cuts, Ms Reeves has limited room to manoeuvre. She’s boxed in by promises not to raise income tax, VAT, or other levies on “working people,” and taxes on capital — like inheritance or capital gains — can only go so far.

Gilt yields could punish any misstep

To make matters worse, bond market trends are adding to the pressure on government finances. Escalating global inflation concerns and fewer price insensitive buyers such as pension funds have helped pushed up yields on UK government bonds, adding to the question marks around the UK’s fiscal credibility. The widely followed 30-year gilt yield, the benchmark for long term government borrowing costs, recently approached its highest levels in three decades, topping 5.5%. 

At this sort of level any misstep such as a clumsy handling of previously “iron clad” fiscal rules could be severely punished by markets, risking a ‘doom loop’ of ever higher borrowing costs, greater economic pain, and lower tax revenue. The Chancellor needs to keep bond markets onside as a matter of priority as waning investor confidence from this point could be hugely damaging. 

No easy options

Given the circumstances it’s no wonder the rumour mill is already turning around what the Budget might hold, even before a date has been set. The Chancellor faces an incredibly difficult balancing act with Damoclean bond yields adding to the jeopardy.

Some combination of spending cuts and higher taxes would likely do the trick, but the former is politically challenging, while the latter could undermine the trajectory required for the UK to grow its way out of its current malaise. 

Last autumn’s Budget placed the burden on businesses through higher employment costs — and the economy has felt the consequences. Many companies have frozen hiring or chosen not to replace departing staff. Reeves will be wary of doubling down on that approach.

Meanwhile, capital taxes like Inheritance Tax and Capital Gains Tax, which make up just 1% and 1.5% of total tax revenues respectively, offer little scope for meaningful gains. And it’s unclear whether recent changes will boost the Treasury’s coffers significantly once their impact on investment and growth are considered, as well as any behavioural response.

In short, there are no good options. Breaking a manifesto pledge on income tax or VAT may even be on the table, given the scale of the challenge. Expect continued speculation — and plenty of trial balloons in the press — in the long lead-up to Budget day.