UK Economic Stagnation and Fiscal Uncertainty Post-Budget: Assessing the Impact on Equities and Gilt Markets

The UK's 2025 budget, unveiled amid persistent fiscal challenges and a fragile economic outlook, has sparked a nuanced debate about its implications for equities and gilt markets. While the government's measures aim to stabilize public finances and curb inflation, the path to long-term fiscal credibility remains fraught with uncertainty. This analysis examines how fiscal policy shifts, coupled with subdued GDP growth projections, are reshaping investor sentiment and market dynamics.

Fiscal Policy and Economic Projections: A Delicate Balancing Act

The 2025 budget introduced a series of targeted tax increases, including adjustments to savings and investment levies, which are projected to raise £26 billion in additional revenue by 2030. These measures, paired with freezes on energy bills and regulated train fares, reflect an effort to alleviate household pressures while reducing inflationary pressures. However, the Office for Budget Responsibility (OBR) has underscored the fragility of the fiscal outlook, revising GDP growth forecasts downward to 1.5% annually over the medium term-a rate that aligns with the UK's historical trend but falls short of expectations for a meaningful recovery.

The government's creation of a £22 billion fiscal buffer-surpassing the £15 billion anticipated by investors-initially boosted market confidence, pushing UK 10-year gilt yields to 4.55% following the OBR's early report. Yet, this optimism was tempered by concerns over the sustainability of public debt. The OBR noted that while stronger-than-expected wage growth has partially offset fiscal deterioration, structural challenges persist, with deficits projected to remain elevated in the coming years.

Gilt Markets: Short-Term Relief, Long-Term Jitters

The UK gilt market has responded to the budget with a mixed signal. Shorter-term (1–5 years) yields are expected to remain attractive as the Bank of England's anticipated rate cuts and subdued inflation reduce borrowing costs. Goldman Sachs Research forecasts a decline in 10-year gilt yields from 4.45% to 4.25% by year-end 2025 and further to 4% by 2026, reflecting expectations of a more favorable macroeconomic environment.

However, longer-term yields (7–10 years) remain elevated due to lingering political and policy uncertainties. The risk of fiscal reversals-such as future tax hikes or spending cuts-has kept investors wary, particularly as the government's reliance on short-dated bond issuance has not fully dispelled concerns about debt management. This dichotomy highlights the market's struggle to reconcile near-term fiscal discipline with the long-term credibility of the UK's fiscal framework.

Equities: A Tale of Two Sectors

The impact of the budget on UK equities is similarly fragmented. Large-cap companies in the FTSE 100, which derive most of their revenue from international markets, are less directly affected by domestic fiscal policies. However, smaller and mid-cap firms face headwinds from higher taxes on savings and investment, which could dampen consumer and business spending.

Goldman Sachs notes a shift in investor sentiment toward UK mid-caps, driven by the prospect of rate cuts and an improved fiscal outlook. This trend contrasts with the relative resilience of FTSE 100 stocks, which benefit from their global exposure. The budget's emphasis on fiscal discipline, meanwhile, is expected to support a gradual reduction in interest rates-a boon for domestic and rate-sensitive equities.

Economic Outlook: Cautious Optimism Amid Structural Headwinds

The UK's economic trajectory remains cautiously optimistic, with GDP growth projected at 1.1% in 2026 and inflation expected to fall to 2.3%. The Monetary Policy Committee (MPC) is anticipated to cut interest rates four times in 2026, bringing the policy rate to 3% by summer. Yet, these projections hinge on the government's ability to maintain fiscal credibility while navigating political pressures.

The OBR's analysis underscores the risks of "can-kicking" strategies, where short-term fixes delay necessary structural reforms. Without meaningful growth-boosting measures-such as investments in infrastructure or innovation-the UK's economic stagnation may persist, further complicating the path to fiscal stability.

Conclusion

The 2025 UK budget has provided a temporary fiscal buffer and signaled a commitment to reducing borrowing costs, yet it has done little to resolve the deeper structural challenges facing the economy. For investors, the key takeaway lies in the asymmetry of risk: while short-term gilt yields and rate-sensitive equities may benefit from a more accommodative monetary environment, long-term fiscal uncertainty and weak GDP growth projections continue to cloud the horizon. As the government balances political expediency with economic pragmatism, markets will remain on edge, awaiting clarity on the path to sustainable growth.