GBP and FTSE 100 trade with caution ahead of the UK Spring statement

As borrowing costs continue to rise in the UK, the government’s £10bn fiscal headroom outlined in last October’s statement is quickly diminishing. For months, Chancellor Rachel Reeves has postponed any major fiscal adjustments, aiming instead to address them in the upcoming Spring Statement. With the pressure mounting, many now expect Reeves to bend or even break her self-imposed borrowing rules in a bid to stabilise public finances.

While the Spring Statement is not a formal budget, it serves as an important platform for the Chancellor to update MPs on the overall state of the economy and to present the latest forecasts from the Office for Budget Responsibility (OBR). Key for market watchers will be whether these forecasts show a gloomier outlook, particularly amid concerns about slowing growth and persistent inflation.

Rising Costs and Fiscal Constraints

Since the Autumn, both inflation and government bond yields have moved higher, driving up borrowing costs. Elevated inflation—further influenced by the inflationary implications of Trump's proposed tariffs—has led markets to reduce expectations for Bank of England rate cuts. This limits the potential relief on government borrowing and has put further strain on the UK’s fiscal balance.

On the tax front, immediate increases seem unlikely. Any significant tax changes are more likely to be reserved for the October budget. However, the Chancellor may need to scale back public spending plans if she intends to restore fiscal headroom and stretch the remaining budget margin until the autumn. While short-term options may be available to patch the fiscal gap, long-term structural challenges remain, particularly with anticipated increases in military expenditure. Simply reallocating funds between departments won’t be a sustainable solution.

Reeves’ Balancing Act

Chancellor Reeves is expected to favour spending cuts over immediate tax hikes in the Spring Statement, positioning herself as a steward of fiscal responsibility. The aim will be to demonstrate a commitment to long-term stability while addressing short-term borrowing pressures. The hope is that by the time the Autumn budget arrives, the Bank of England may have delivered more rate cuts, easing pressure on the fiscal outlook. A decline in gilt yields would also be a welcome windfall, although global expectations for rising yields—particularly in the US and Europe—cast doubt on that possibility.

Market Response and Risks

UK assets have been trading cautiously amid the uncertainty surrounding the Spring Statement. What was expected to be a routine forecast update has increasingly taken the shape of a mini budget, limiting any upside in UK equities and sterling over the past few days.

However, markets may be underestimating the risks to the UK’s public finances. The combination of rising debt levels, tepid growth, and stubborn inflation creates a challenging environment for UK assets to outperform. The situation could deteriorate further if fiscal credibility comes into question.

The market reaction to Wednesday’s statement will largely hinge on how convincingly Chancellor Reeves presents her plans to contain spending and avoid a further rise in national debt. A lack of clarity or conviction could prompt another rise in gilt yields and dampen sentiment around the pound and UK stocks, reflecting waning confidence in the UK’s fiscal position.

FTSE 100 daily chart

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