The UK’s Policy Crossroads: Debt, Inflation, Growth — and the Budget to Come
The UK faces a familiar but intensifying set of pressures: government debt near historic highs, deficits that refuse to shrink meaningfully, inflation that remains persistently above target, growth underwhelming, and asset prices, especially property, that are elevated relative to their economic fundamentals. With these tensions mounting, the options for policymakers are limited, and none of them painless.
One route is to tighten fiscal policy: reduce spending, raise taxes, and signal strict discipline to reassure markets and help bring inflation down. This path risks choking off already fragile growth and triggering negative feedback loops for investment and asset values. The alternative is to lean into loose monetary and fiscal policy: maintain or increase support for the economy and asset markets, but accept rising inflation, increasing debt servicing costs, and a weakening currency.
This dilemma looms large as we approach the Autumn Budget scheduled for November 2025. Chancellor Rachel Reeves will need to address a growing fiscal gap just as borrowing costs rise sharply, particularly for long-dated gilts, and inflation and wage pressures continue to squeeze public finances. Reports suggest that the Office for Budget Responsibility (OBR) may downgrade its productivity forecasts, potentially worsening the fiscal shortfall by up to £30 billion. Such revisions will tighten the room for manoeuvre in November’s Budget. If past pledges are to be honoured, such as limiting tax increases on working people while adhering to fiscal rules, then significant trade-offs will be unavoidable.
Recent data underscores the tightrope. Public sector net debt has climbed to around 96% of GDP, among the highest in decades. Borrowing in the first four months of fiscal year 2025/26 hit £60.0 billion, which is about £6.7 billion more than in the same period last year, though broadly in line with forecasts. Inflation remains sticky at about 3.5% and real incomes remain under pressure. Meanwhile, gilt yields have risen, for example, 10-year government borrowing costs are now among the highest in the OECD, reflecting heightened risk premia in addition to expectations of “rates higher for longer.”
Markets are already reacting. Long dated gilt yields have risen even as focus shifts towards possible rate cuts in the short term. There is a rally in gold and other hard assets as investors seek protection, while equities—though still holding up—face growing headwinds from weaker growth and more expensive financing. The pound has shown signs of strain, particularly in the face of inflation that erodes real value and concerns about long-term fiscal credibility.
With the Autumn Budget looming, several dynamics will likely come to a head. The government may have to choose among raising taxes (or freezing thresholds, which acts like a stealth tax), cutting certain expenditures, or altering the mix and maturity of public debt. There is also likely to be pressure to reduce the pace of gilt sales by the Bank of England or to move to more passive quantitative tightening, to relieve strain in the gilt market. One advantage the UK does have is that the weighted average maturity of its outstanding debt is roughly double the average of the G7 economies. This should give it more scope to shift issuance to the front end to help support the long end. However, building in realistic projections for growth (especially bearing in mind possible weaker productivity) will be essential, else forecasts may again prove over-optimistic and the fiscal gap larger than anticipated.
When the turning point arrives, when rate pressures and yield curve dynamics force more aggressive action on the long end, many investors will breathe a temporary sigh of relief. Bonds may rally; risky asset prices may receive a boost. But the cost will likely come in currency weakness, inflation persistence, and erosion of purchasing power.
Ultimately, only when inflationary pain becomes politically and socially intolerable will policy swing decisively toward austerity and frugality. Until then, the November Budget may serve both as a signal and a test: can the government navigate the trade-offs of fiscal sustainability without undermining growth, without losing control of inflation, and without destabilising markets? It would take a brave soul to answer yes to that question.
