Why Wednesday’s Budget means so much for the UK economy

This announcement comes at a time when the state of the economy remains a serious concern, especially after industry criticism of the impact of the government's first budget last year.

Further fueling this expectation, the state's official forecaster is about to release its main economic projections for the coming year, raising concerns about a potentially disappointing short-term outlook.

Here we look at the significance of this budget for the economy:

What is the budget's background?

The UK economy started the year with positive growth, with GDP (Gross Domestic Product) expanding by around 0.7% in the first quarter of the year.

Nonetheless, this growth was boosted by strong trade ahead of the expected tariffs, and this occurred amid an increasingly uncertain global economic backdrop.

As the year progressed, this growth steadily slowed, with the Office for National Statistics (ONS) reporting growth of 0.3% in the second quarter and 0.1% in the third quarter. This decline comes amid a slowdown in the production sector and slower growth in the services sector.

Meanwhile, inflation has risen over the past year, peaking at 3.8% in July, August, and September.

It declined slightly last month—albeit at a lower rate than expected—but this also comes against the backdrop of declining salary growth.

Consumer finance was supported by good salaries, but real salary growth has slowed significantly in recent months due to pressure in the labor market.

Unemployment also increased in the three months through September, reaching a four-year high of 5%.

Why is the final budget important?

Weak hiring, slow salary growth, and inflation are all linked, in part, to policies implemented after the Labor government's first budget last year.

When the policies were implemented in April this year, the budget increased taxes and labor costs for many businesses.

Firms were impacted by the increase in the National Minimum Wage, higher National Insurance Contributions (NICs), a reduction in business rates, and other taxes such as the new packaging tax.

The Bank of England emphasized that the increase in NICs and the minimum wage earlier this year contributed to food inflation to some extent, as affected firms passed some of it on to their customers.

What are businesses thinking ahead of the Budget?

Businesses and trade bodies have emphasized that they were under pressure from the previous Budget and have urged the government not to impose further increases.

Industry data also showed that some businesses have curtailed spending ahead of the Budget, as firms are cautious about their financial position.

The latest monthly flash PMI economic data – which shows activity in the UK private sector – showed that cautious decisions taken by firms ahead of the Budget impacted activity.

What are consumers thinking?

Consumer spending has also been cautious in recent months, with Bank of England policymakers recently focusing on saving rather than spending.

On Friday, the ONS said retail sales fell for the first time in three months in October as shoppers also held off on purchases ahead of the Budget.

Economists have warned that a larger-than-expected increase in personal taxes in the Budget means some consumers will reduce their spending plans rather than postpone them until closer to Christmas.

Ruth Gregory at Capital Economics said: "The risk is that the fourth quarter is not good for retailers, and the higher taxes in the Budget will deter retail spending during this crucial festive period and will continue to do so next year."

Why has the government's 'fiscal hole' received attention and what does it mean?

This is particularly important for the government as it seeks to meet its fiscal rule of balancing expenditure and revenue over the next five years.

Economists have estimated that a large "fiscal hole" has widened since the last Spending Review, with spending reduced due to a failure to address welfare cuts, increased borrowing costs, and a smaller-than-expected change in productivity estimates.

Nevertheless, reports suggest that initial estimates of a fiscal hole of around £30 billion have now narrowed, with the Financial Times indicating that the OBR believes it will be closer to £20 billion.

Last week, reports indicated that the government will not proceed with an income tax increase as expected because it does not need to raise that much money to cover the shortfall.

On Wednesday, the Office for Budget Responsibility will reveal how much money will be raised through new spending cuts or tax increases to address it.

It will also release its new estimates for key economic metrics such as economic growth, unemployment, and inflation.

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Will the budget be significant for the financial markets?

The budget could impact trading in the financial markets, as there is considerable speculation about potential policy decisions.

Generally, the value of the pound and the price of gilts – government bonds – are likely to be most affected by budget policy.

Gilt yields, which rise when prices fall, rose higher earlier this week but are still significantly lower than at the beginning of the year as borrowing costs have declined amid low interest rates.

Both the pound and gilt prices respond positively to promises of cautious spending and limited tax changes, especially if they believe tax policy could hinder economic growth or large investments.

The FTSE 100 and other domestic equity indices are not directly affected by domestic policy changes, although they may be affected by fluctuations in the pound.

However, the value of stocks in specific sectors targeted by policy may fluctuate.

For example, listed gambling companies have seen their share values ​​impacted by speculation about increased taxes on sports betting.