UK’s Lack of Fiscal Space Expected to Prevent Marked Policy Easing
The UK faces higher fiscal policy uncertainty amid an expected leadership transition, but market discipline should limit major loosening. High debt and inflation-linked servicing costs constrain creditworthiness, while elevated yields reflect monetary expectations and a weaker growth outlook.
There is greater near-term fiscal policy uncertainty in the UK and pressure on spending as a result of the likely transition to Andy Burnham’s leadership, but a sizeable loosening or change to fiscal rules is not expected given the risks to gilt yields, Fitch Ratings says in a new report.
A tilt in the fiscal mix more towards spending is likely to be limited in scale given constraints to further raising taxes, according to Fitch.
The firm said Burnham’s more commanding position within the parliamentary Labour Party, and higher public approval ratings, may support moderately more political stability for the remainder of this parliamentary term.
UK fiscal uncertainty has contributed to gilt yield volatility, Fitch said, weighing on sentiment, particularly at points when there have been greater concerns that fiscal rules could be relaxed.
Fiscal rules have assumed greater prominence under the Labour government, partly as a bulwark against higher spending pressures from elements of the Labour Party and reflecting some improvement in the fiscal framework.
Fitch Ratings forecasts the general government deficit to narrow by 0.6pp in 2026 to 4.8% of GDP, and to 4.5% in 2027, 0.8pp slower than government plans, due to spending overruns.
UK general government debt/GDP is projected to rise to 106% at end-2028, from 102% at end-2025. Fitch said such high debt/GDP, more than double the ‘AA’ median, limits the scope for further fiscal slippage without leading to pressure on creditworthiness.
High nominal gilt yields are driven more by market expectations for policy interest rates, which are 150bp higher (five years ahead) than in the eurozone, and by recent inflationary pressure.
To a lesser extent, they also reflect relatively rapid quantitative tightening and a fall in demand from the pension sector. A greater share of gilts are also now held by more price-sensitive investors and for trading purposes, amplifying the sensitivity of gilt yields to global and UK-specific shocks.
