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Investing.com - U.K. Chancellor Rachel Reeves faces mounting fiscal pressure after the government’s recent U-turn on welfare cuts, potentially eliminating her £10 billion fiscal headroom.
The gilt market sold off amid speculation about Reeves’ position, though the Prime Minister’s office has officially backed her.
Bank of America (NYSE:BAC) analysts believe the Chancellor staying in her position would likely reassure markets that current fiscal rules will remain in place.
BofA estimates that recent policy reversals, including the welfare cuts U-turn and winter fuel payment changes, have already reduced the fiscal headroom by approximately £6.25 billion.
Combined with potential growth downgrades in the Autumn budget, the bank projects headroom could be reduced by £20-30 billion total, turning the current surplus into a deficit.
The Office for Budget Responsibility noted this week it has previously been overly optimistic in growth assumptions, raising the likelihood of medium-term growth downgrades that would further impact fiscal calculations.
BofA analysts expect the OBR will likely downgrade GDP growth by at least 10-20 basis points on average across the forecast horizon.
BofA’s base case remains that the Chancellor will undertake fiscal consolidation to restore headroom, with the majority likely coming through tax rises rather than spending cuts, which face significant political challenges after this week’s near-rebellion on welfare reforms.