Reeves' Budget and the Road to the Bank of England's Rate Cut

Chancellor Rachel Reeves' 2025 Budget has sparked significant debate about its implications for inflation, economic growth, and the Bank of England's (BoE) monetary policy trajectory. By introducing a mix of tax hikes, public spending reforms, and inflation-targeting measures, the government aims to balance fiscal responsibility with growth-oriented strategies. This analysis examines how these fiscal measures are shaping the UK's economic outlook and their potential to catalyze BoE rate cuts in 2026, while also assessing the implications for government bonds and equity sectors.

Fiscal Measures and Inflation: A Delicate Balance

The budget's tax hikes, including a surge in Remote Gaming Duty to 40% and a 25% increase in online betting duty, are designed to bolster public finances but risk dampening consumer spending. Conversely, the abolition of the two-child benefit cap-a £3.6 billion annual commitment-could inject disposable income into households, potentially exerting upward inflationary pressure. However, the Office for Budget Responsibility forecasts inflation easing to 3.5% in 2025 and 2.5% in 2026, supported by measures such as freezing income tax thresholds and reducing household energy bills. According to a report by Bloomberg, these steps are expected to lower inflation by 0.5 percentage points in Q2 2026, creating a temporary tailwind for the BoE's rate-cutting agenda.

That said, long-term inflation risks persist. A 4.1% increase in the national minimum wage and the freeze on salary sacrifice schemes could reignite wage-driven inflation, complicating the BoE's efforts to meet its 2% target. Core inflation, while showing signs of easing in October 2025, remains a critical metric for policymakers.

Growth Prospects and the BoE's Rate-Cutting Path

Reeves' budget emphasizes growth through infrastructure investments, trade deals with the US, India, and the EU, and NHS modernization. The allocation of £4.9 billion in NHS savings to hire nurses and improve GP services, alongside £300 million for technology upgrades, signals a focus on productivity. These measures align with the government's ambition to position the UK as the second-fastest growing G7 economy in 2025, according to analysis.

The BoE's rate-cutting trajectory, however, hinges on the success of these growth initiatives. As noted by Reuters, the BoE is projected to cut rates to 3.75% in December 2025 and reduce them by 64 basis points by year-end 2026. This optimism is partly driven by the budget's inflation-curbing measures, which have reduced the central bank's hesitation to act. Yet, if wage growth outpaces productivity gains, the BoE may face renewed pressure to delay rate cuts.

Government Bonds: Volatility and Fiscal Uncertainty

The UK bond market has reacted cautiously to the budget's mixed signals. While the OBR's inflation forecasts and temporary inflation-lowering measures have eased some concerns, the absence of broader fiscal tightening has fueled market skepticism. According to Morningstar, bond yields spiked in early 2025 and again in late September amid uncertainty over the government's ability to meet its fiscal rules.

For bond investors, the key question is whether the government can demonstrate sustained fiscal discipline. If Reeves' administration successfully balances growth and deficit reduction, bond yields could stabilize or decline, offering a favorable environment for gilt holders. However, any deviation from fiscal targets-such as underfunded public spending commitments-risks reigniting volatility.

Equity Sectors: Winners and Losers in a Shifting Landscape

Equity markets have shown a nuanced response to the budget. The FTSE 250, which includes domestically focused sectors like banking, gambling, and real estate, faces headwinds from tax hikes and regulatory changes. For instance, the mansion tax and restrictions on salary sacrifice schemes could pressure banking sector profitability, while the gambling industry contends with higher levies on online betting.

In contrast, the FTSE 100, with its international exposure, appears less vulnerable. However, utilities and energy firms may benefit from the government's focus on reducing household energy bills, though long-term profitability could be affected by inflationary wage pressures. Investors are advised to adopt a sector-specific approach, favoring companies insulated from domestic fiscal shifts.

Election Risks and the Road Ahead

The May 2026 elections introduce an additional layer of uncertainty. If Labour's fiscal policies face political headwinds, a shift toward increased public spending could reignite inflation and borrowing costs, complicating the BoE's rate-cutting plans. Conversely, a reaffirmation of fiscal discipline would reinforce confidence in the UK's economic trajectory.

For now, the budget has created a fragile but plausible path toward BoE rate cuts. Investors should monitor inflation data, wage growth, and fiscal rule adherence closely. In bonds, patience may be rewarded if fiscal credibility holds; in equities, sectoral differentiation will be key to navigating the evolving landscape.