Chancellor John Healey faces a “tricky Budget” in a couple of weeks as markets wait to see whether he will continue the fiscal responsibility preached by his predecessor or start to loosen the reins, according to Amundi's Grégoire Pesques.
“We have very little information so far,” said Pesques, chief investment officer of global fixed income at Amundi. However, he noted it was a “big relief” to markets when prime minister Andy Burnham and Healey committed to their predecessors' fiscal rules at the Labour Party conference late last month.
“This government was initially perceived as very left leaning. I think, given the situation, they know that they can't afford any more spending that will not be financed or credible,” he said.
The government has little room to spend because bond yields have spiked, meaning the cost of debt is much higher. In the UK, the 10-year gilt yield has risen above 5.4%, more than 1 percentage point higher than a year ago and almost 1.2 percentage points above its lows in March.
Pesques said the government will likely be given leeway if bond markets continue to deteriorate, as the recent moves have been part of a worldwide sell-off whereby bond vigilantes have started to question the sheer volume of government debt around the world.
“Fiscal risk is everywhere. It's in the eurozone, it's in the UK, it's in Japan, it's in the US,” said Pesques.
“You need credibility both on the budget side and you also need credibility on central banks,” he added. This is something that has been lacking in the US in particular as the country has spent more (and committed to future spending), while the independence of the Federal Reserve has been questioned after comments made by president Donald Trump throughout his current term.
“It's a global phenomenon. The US is part of the game, but it's a global phenomenon. When you look at debt-to-GDP metrics since Covid, all countries experienced severe deterioration,” said Pesques.
“None of them are cutting spending. The few countries that did this are either emerging market countries or, closer to us, the government has been sacked after a rebellion within the parliament or a coalition break,” he noted, showing how difficult it is politically for governments to make meaningful changes.”
Even former chancellor Rachel Reeves, who was outspoken in her need to increase fiscal headroom during her time at No 11 Downing Street, “failed” to appease bond investors in her two Budgets. The first was too inflationary, while the second was “a bit better” but was still “mixed”, the Amundi CIO said.
At the upcoming Budget on 28 October, Pesques expects announcements that will be relatively unimportant in the grand scheme of the country’s finances and that will be short-lived, such as an extension of the cut to VAT on domestic electricity bills from 5% to 0% that started on 1 October 2026 and is due to end on 31 March 2027 – a policy that has already been implemented in other countries since the outbreak of the Iran war.
“What the market will look for is: is this government looking to or able to cut spending in some ways? That will be very positive news. They were trying. They discussed a bit about the triple lock, but I think it's not for now. In the meantime, I don't expect big news, both in terms of cutting spending and in terms of tax,” he said.
He noted that there have been discussions on ways to raise tax, from housing to banks to inheritance, but Pesques said these will not be coming “in a meaningful manner” at this Budget.
“So I don't have, and I think the market doesn't have, a big expectation,” he said.
What will be closely monitored is the fiscal headroom – something that has been reduced meaningfully this year. Reeves had built up the country’s headroom to around £24bn, a figure that has been slashed due to factors such as gilt yields rising and inflationary pressures from war in the Middle East.
Pesques said some estimates suggest the headroom figure has dipped below £10bn, adding that the market will expect the total to be a double-digit number at a minimum.
“There was a good buffer in terms of fiscal headroom, and we had the Middle East event. That's the purpose of having buffers, but I think the market will be disappointed if this buffer is below £10bn,” he said.
With a large majority, the government has the luxury of making bold decisions, such as raising taxes. He noted that in other countries such as France, coalitions have made it difficult for the government to take decisive actions.
“When you have a majority, you can take action. It's the question of being able to unify your party around specific important strategic measures that you want to implement and maybe Burnham is better placed than his predecessor, in terms of being able to unify the party and take some measures that maybe are not very popular, even for the left wing,” he said.
Pesques also praised the Debt Management Office (DMO), which he said has acted “very smartly” with its management of government bonds, reducing supply of long-term debt. This combination of a “pragmatic” DMO and a clear majority in parliament should give the government the chance to cut spending, although the Amundi CIO said the cuts are unlikely to be as large as he believes they should be.
It also presents an issue for Burnham and Healey, he noted, as it is easier to blame governments that have full control than those in coalitions or with weak majorities.
“They have the flexibility, so they have a good opportunity. Unfortunately, I don't think they are going to cut spending as much as I think they should do, but they have this option,” he said. “At least we will be able to blame them.”