Stock Market & Economic Commentary - October 2025

The UK’s policy crossroads: debt, inflation, growth — and the Budget to come

The UK is facing a familiar but intensifying set of pressures. Government debt is near historic highs, deficits that refuse to shrink, persistent above target inflation, anaemic economic growth and, in recent months, rising unemployment. With these tensions mounting, the options for policymakers are limited. And none of them are painless.

A year ago, Britain’s chancellor, Rachel Reeves, said that the £40 billion of tax rises announced in her October budget (the largest in 30 years) were needed, “to wipe the slate clean and put our public finances on a firm footing”. The following month, Ms Reeves told the CBI that she would not be “coming back with more borrowing or taxes”.

Things have not turned out as the chancellor promised.

Government borrowing is running well ahead of Ms Reeves’s plan. In the first five months of 2025/26, the government borrowed £83.8 billion, £16.2 billion more than in the same period last year and £11.4 billion more than planned. Without higher taxes or cuts to public spending, or a return to steady, sustainable economic growth, the chancellor is likely to miss her own rule for reducing debt, which she has repeatedly described as being “non-negotiable”.

The true scale of the problem is greater than these numbers imply. Higher government borrowing costs, government U-turns on cuts to winter fuel payments and sickness and disability benefits, and an expected downgrade to the Office for Budget Responsibility’s (OBR) estimate for UK productivity growth have created a hole in the public finances.

Estimates of the size of the fiscal gap vary, but a figure of around £30 billion seems plausible. To this, it would be prudent to add a margin of error of at least £10 billion to avoid being blown off target by future shocks and surprises. That would leave the chancellor needing to find around £40 billion in her budget on 26 November, an amount similar to the scale of last October’s tax rises.

The obvious solution would be to change the fiscal rules to allow more borrowing. That would be risky. High inflation, government borrowing, and a falling away of demand for gilts from a shrinking pool of UK defined benefit schemes mean that the UK government already faces interest rates that are higher than its European or North American peers. To overturn what the chancellor has described as ‘ironclad’ fiscal rules – in what would be the eleventh change to the rules in 18 years – to fill a hole in the UK public finances could test the patience of the bond market.

That leaves the chancellor facing a choice between reducing public expenditure and raising taxes.

The government’s inability to win the support of its backbenchers for relatively modest welfare cuts earlier this year suggests significant reductions in public spending are not on the cards. In any case, the existing plans for departmental spending for the next four years, which were unveiled in July, already look tight, and public dissatisfaction with services is high.

This leaves taxes.

The Party’s manifesto stated that, “Labour will not increase taxes for working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.” The chancellor said last month that the manifesto pledge stands, but other comments seemed designed to create more room for manoeuvre on tax. Before her speech to the Labour Party conference, Ms Reeves said that “the world had changed” since last year’s budget due to a combination of conflicts, US tariffs and higher borrowing costs. The chancellor’s comments have been widely construed in the media as meaning that she no longer stands by last year’s pledge not to raise taxes.

Chancellors occasionally raise significant revenues through a single tax change – as with George Osborne’s increase in VAT to 20% in 2010, Rishi Sunak’s introduction of the Health and Social Care levy in 2021, and Ms Reeves’s increase in employers’ NICs last year. These are the exceptions. Chancellors tend to favour a mix of smaller tax-raising measures, sometimes stealthy, such as freezing income tax allowances.

The media have speculated about the possibility of a wide range of tax-raising measures in recent weeks. Some of the larger revenue-raising measures that have attracted discussion include extending the freeze in income tax allowances, reducing pension reliefs, increasing Council Tax and extending the VAT base. What is clear is that the chancellor could raise £40 billion or even more through a series of smaller tax measures and without increasing rates of income tax, VAT or national insurance.

An easy target, again, would be pension reliefs. Charging NIC on employer pension contributions, reducing pension tax relief for all taxpayers to 20%, and restricting the pension lump sum allowance to £100,000 would raise a combined amount of £34 billion. Problem solved… well, almost!

Changes to Inheritance Tax gift exemptions and potentially exempt transfers have also been widely predicted, along with imposing Employer’s NIC (15%) on partnership profits.

Implementing a host of tax-raising measures may seem the least risky course of action, but as the Institute for Government (IfG) has observed, “small isolated [tax] changes can create a concentrated group of losers and attract outsized bad press”. More fundamentally, the IfG also cautions that, “an eclectic grab bag of tax raisers that complicate an already inefficient tax system would hamper, not promote the government’s key aim of supporting growth”.

Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible number of feathers with the smallest possible amount of hissing.” £40 billion of tax rises would occasion a good deal of hissing. With the tax burden already at the highest level in more than 70 years, perhaps the more pertinent question is what £40 billion of additional tax increases might do to the health of the goose.

“Pessimism leads to weakness; optimism leads to power.”

William James (1842-1910) – Pioneering American philosopher and a founder of modern psychology in the USA.

In all my years as a financial adviser, it feels like periods of benign calm have been few and far between. The current bout of political upheaval, wars and stock market swings is certainly not one of them. Part of the reason it feels this way is because we tend to remember the times of turmoil and volatility more clearly than we recall the ‘ordinary’ years.

In fact, we only need to look back as recently as the 2010s to find a time that, with hindsight, was an era of relative calm. It was a decade that lulled many investors into a false sense of security. Of course, there were notable market and corporate events, but on the whole, markets trended upward, politics were relatively stable, and economic shocks were rare.

What we can now see is that the 2010s were the exception, not the rule. The 2000s decade, by contrast, was marked by major events such as the dot-com technology boom and bust, the 9/11 bombing of the twin towers, the start of the 20-year war in Afghanistan and the global financial crisis.

What we are currently experiencing – a return to more frequent and sharper market movements and geopolitical uncertainty – is arguably a reversion to normality.

Reasons to be cheerful

While volatility and geopolitical tensions might dominate the macroeconomic narrative, there are more powerful, but less noticeable forces that are shaping the future.

The 2000s may have been a turbulent decade, but micro-level innovations emerged that had a more tangible long-term impact. For example, few would have predicted the profound effect the iPhone would have on our lives when it launched in 2007, and yet it ended up having a more significant and lasting impact than the global financial crisis, which was occupying the minds of most investors that year.

The 2000s were also the decade in which the internet really came into its own and started reshaping every aspect of our lives.

In a famous interview in 1999, Jeremy Paxman showed scepticism towards David Bowie’s view that the internet would change the world forever. Viewed through the lens of history, we can now see that Bowie was right. And, despite similar scepticism among some commentators, it seems like we are now at a similar inflexion point with Artificial Intelligence (AI).

AI is already reshaping industries, and its potential is staggering, but just as we were using the internet to watch funny cat videos in 1999, we are still only playing around with AI’s potential. As adoption accelerates, it could drive productivity gains across the economy, much like the internet did.

Some experts believe AI’s impact could be many times that of the internet. While he may have a vested interest, Sundar Pichai, CEO of Alphabet and Google, claims that “AI is one of the most important things humanity is working on. It is more profound than electricity or fire.”

It is also important to remember that the digital revolution requires a robust physical foundation. From data centres to resilient power grids, infrastructure investment is booming. This is being driven by trends like reindustrialisation, decarbonisation, and the need for digital connectivity. It’s the type of companies providing these services, which often operate away from the limelight and therefore have more sensible valuations, that could provide some of the best investment opportunities in the longer term.

It’s not just the technology sector that could produce the kind of productivity shifts that boost global growth. There are also developments in healthcare, such as obesity drugs and cardiovascular care, which may have far-reaching implications.

For example, researchers have developed a miniature camera, coupled with deep learning, that can be inserted via a catheter and offers unprecedented, real-time analysis of the coronary arteries. This innovation is expected to revolutionise cardiovascular diagnostics and intervention by enabling risk detection of blockages previously invisible to standard imaging techniques.

Improvements in the health of individuals could lead to major savings within public health systems. In turn, the potential benefits for society, the economy and stretched public budgets are immense.

Global growth is broadening

Another reason for optimism is the shifting landscape of global growth. For the first time in years, regions like Europe and China are taking more proactive roles in stimulating their economies. Europe is moving away from its traditional austerity mindset, while China is stepping up efforts to stabilise growth. Together, these regions represent a larger economic bloc than the US, offering a potential counterbalance to any slowdown in American growth.

Emerging market equities have performed well in recent months and have kept pace with, and in some cases outperformed, developed markets. There has been much commentary on the performance of the US mega-cap technology stocks, but it is notable that emerging markets have beaten the US indices year-to-date.

Overall, the significant valuation discounts to US equities, coupled with the greater growth opportunities, mean that investors should maintain a meaningful allocation to emerging markets and Asia. The diversification of economic drivers is leading to a more balanced global economy – one where investors don’t have to rely solely on the US for returns.

Micro beats macro

Much of today’s political instability stems from a broader dissatisfaction with how the benefits of globalisation have been distributed. Over the past decade, asset owners have seen their wealth grow, while real wage growth for many workers has stagnated. This imbalance has fuelled populist movements across the globe. These political shifts are symptoms of a deeper issue: a sense among many that the economic system no longer works for them. While this discontent is real and must be acknowledged, it’s also important to recognise that political cycles are, by nature, temporary.

And just as happened in the 2000s, it is the gains from as yet unknown micro developments that are likely to deliver the growth we need to prosper and return to a more stable world. These trends are not only investable, but they are also long-lasting. Unlike political leaders, who come and go, the impact of these innovations will be felt for decades.

It’s also important to remember that despite the alarming news flow, corporate earnings have continued to grow. This resilience is a key reason why equity markets have performed better than many anticipated. For a sterling investor, the US market is flat on the year, but Europe, the UK and Asia have all posted gains. This suggests that investors are recognising the strength of the corporate sector, even amid macro uncertainty.

Headlines may shout of storms ahead, but beyond the noise, the sun still rises. In the words of Albert Einstein: “In the middle of difficulty lies opportunity.”

As always, we thank you for your continued support, and we look forward to updating you regularly for the remainder of 2025 and beyond. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

October 2025

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Stock Market & Economic Commentary – October 2025