Is the autumn budget enough to reassure markets and shift BOE hike expectations?

The autumn budget is scheduled for 28 October, just one week before the BOE's next rate-setting meeting. Given lingering inflation concerns, the Treasury's fiscal package could help determine how interest rate expectations evolve over the coming months.

As things stand, markets assign roughly 99% odds to a 25-basis-point rate increase at the November gathering. Barring a major surprise, that move appears all but determined. December, however, is more uncertain: traders see approximately a 47% chance of another hike by year-end. That is almost a coin flip, and the budget could nudge expectations in either direction.

What might traders need to keep an eye on?

To begin with, the prevailing expectation is a conservative budget: small tax hikes and household-specific aid, not big spending pledges.

The fiscal backdrop is decidedly strained. EY figures show the buffer against the government's own fiscal rules has fallen to an estimated £11.3 billion, down from £23.6 billion in March. Much of the erosion stems from elevated borrowing costs and the economic effects of the Iran conflict.

According to a recent Reuters poll, Healey should aim to restore that buffer to roughly £15-16 billion to soothe bond investors, giving markets a useful yardstick for assessing the budget.

For revenue, Healey may rely mainly on a higher bank-profits levy. There is also talk of lowering the threshold for the mansion tax, bringing properties worth over £1.5 million into scope, compared with £2 million now.

In addition, focus is on energy subsidies for poorer families, electricity bill discounts, and possibly extending the fuel-duty reduction. The key issue is how much aid Healey can provide without increasing borrowing. Since markets anticipate a disciplined budget, any spending over and above forecasts could quickly trigger worries about financing.

Measures that cut household energy or fuel outlays could ease immediate inflation and thereby lessen pressure on the BOE. But direct cash transfers might just boost consumer spending instead. Thus, the specifics and the funding plan will be crucial.

On the spending side, Healey is likely to avoid major pledges on housebuilding, defence and public services, deferring many choices to 2027. That could reassure gilt buyers, if the government's borrowing projections remain intact.

Here, the OBR's revised inflation, growth and borrowing projections will be closely watched, since they will help markets determine whether the fiscal picture is getting better or worse. If stronger inflation and higher debt costs make the outlook dimmer even with restraint, gilt yields may face upward pressure.

Taken together, the crucial market task is to separate yield increases driven by inflation expectations from those driven by concerns over fiscal credibility. Each has distinct consequences for monetary policy.

A believable budget that keeps borrowing in check, dampens demand and cools near-term energy inflation might prompt traders to trim their expectations of BOE hikes in December and beyond. Conversely, if the plan fuels inflation, investors could more readily conclude that another rate increase is warranted.

With current pricing, the November rate rise is essentially locked in, so the main repricing chance rests on the December meeting.

Still, the budget is only one factor. UK inflation and employment figures will remain significant drivers of market expectations, shaping the outlook for both December and next year.