Leading Indicators | The Budget comes first: why fiscal policy could shape the BoE's next move

Persistent Middle East tensions have tipped the balance towards a rate hike

The BoE held rates at 3.75% last week, but persistent tensions in the Middle East have triggered a rise in energy prices, adding to near-term inflationary pressures. Economists now expect a +25bp hike in November, taking rates to 4.00% by year-end, though we believe markets are overpricing a move to 4.75%. Continued labour-market weakness should limit domestic inflation persistence, supporting rate cuts from late 2027 or 2028.

Increasing global bond yields put pressure on fiscal headroom 

Global bond yields remain elevated amid a broad sell-off across developed markets. US 30-year treasury yields have topped 5.3% in recent weeks for the first time since 2007, while UK 10-year gilt yields are around 5.2%. Although higher oil prices and Budget-related fiscal risks could keep yields elevated in the near term, we expect UK gilt yields to fall over the next 12 months as markets scale back expectations for further BoE tightening. A slower pace of gilt sales by the BoE should also provide a more supportive backdrop for government bonds.

With the Budget landing just a week before the next BoE policy meeting, the market's reaction will take on greater importance

The UK is expected to deliver one of the more ambitious fiscal consolidations among major economies, with IMF forecasts showing the deficit narrowing to around 1.6% of GDP by 2031. The October Budget will be a key test of that trajectory, but the market’s reaction may prove just as important as the measures themselves. With the BoE’s next policy decision following a week later, any resulting move in government borrowing costs could influence the outlook for monetary policy.