UK Budget 2025: How troubled are UK public finances?

Ahead of the Autumn Budget, Davy UK Portfolio Manager Ben Banerji looks at the difficult decisions ahead for Chancellor Rachel Reeves as the country grapples with high debt levels, a growing deficit and a challenging global market environment.

Speculation is now well underway about what the Chancellor might announce in the Autumn Budget. The Labour government is in an unenviable position. It must convince investors that it can deliver financial stability without damaging growth, while reassuring voters that its manifesto commitments remain affordable. Much has been said about the ‘broken’ state of the public finances, but compared with the other G7 countries, the picture is more nuanced.

How does UK debt stack up against global peers?

The UK government owes its lenders about £3 trillion. Measured against the size of the economy (debt-to-GDP ratio), public debt is roughly equal to annual output. While in absolute terms this number sounds large, across the G7 it is unremarkable. Only Germany (64%) has a clearly smaller debt burden as a share of GDP.

Debt sustainability depends less on the amount of debt, and more on the government’s capacity to service it. However, the level of debt does limit the governments freedom to spend, at a time when demands on public services are rising.

Figure 1: Debt-to-Debt GDP (%)

Source: IMF, Gross debt. Gross Domestic Product (GDP) is the standard measure of economic activity.

Is the UK’s deficit a concern?

The stock of debt is not an immediate concern, but the budget deficit is. Like other developed economies, the UK runs an annual budget deficit, spending more than it collects in taxes and other revenue. The risk is that this gap grows faster than the economy itself and makes the amount of debt outstanding difficult to stabilise.

However, forecasts from the IMF suggest that the UK could make quick progress in narrowing the deficit. The improvement would not remove the shortfall, but it would put the UK among the more disciplined members of the G7.  

Figure 2: Budget Deficit (as % of GDP)

Source: IMF

Higher interest rates and borrowing costs

Another complication is the rapid increase in interest rates that began in 2022. Higher interest rates mean a larger share of spending must go towards servicing the debt, particularly as the UK has higher borrowing costs than the European Union and Japan.

Despite this, the UK does not pay a disproportionately high share of GDP towards interest. At 3% of GDP, the UK sits only slightly above the G7 average. That average is skewed by very low rates in Japan and the good fiscal position in Germany.

Figure 3: Interest on public debt sa a percent of GDP (%)

Source: IMF. Interest paid on public debt, percent of GDP.

Sticky inflation is slowing interest rate cuts

The Bank of England (BoE) has struggled to bring interest rates down as quickly as it might have hoped because inflation has stayed higher and has been stickier than it has in other regions. Year-on-year CPI (Consumer Price Index) was 3.8% in September 2025, still well above the Bank’s target of 2%. This comes at a time when both the domestic jobs market and economic growth are slowing. But the central bank has a range of tools that they are yet to make full use of. If we do see a slowdown of growth, or instability in the bond market, the central bank can act in a way that doesn’t necessarily lead to more inflation.

Figure 4: Inflation edging higher, but still contained

Source: Bloomberg.  YoY means percentage, year-on-year.

Why long-term yields are rising globally

Bond markets are sensitive to any sign that governments may struggle to manage their debt. The Liz Truss episode in 2022 has left a lasting impression on investors as soaring UK gilt yields underscored the importance of setting out a credible fiscal plan.  

The market yield on a 30-year UK government bond recently rose to its highest level since the turn of the century. Based on the media coverage at the time, you would be forgiven for thinking this was another crisis in confidence. However, this hasn’t been isolated to the UK and since the beginning of 2024, yields have been rising all around the developed world.

Figure 5: Global government 30-year bond deals

Source: Bloomberg.

Growth and fiscal headroom

Strong growth in the first half of 2025 has offered the Chancellor some breathing space. The UK economy (GDP) expanded by +0.7% and +0.4% in the first and second quarter respectively - making it the fastest growing economy in the G7. But growth has slowed since the summer and future growth expectations are lower than peers.  The market is not confident that even the low targets will be met.

The big misstep in the Spring was the amount of fiscal headroom in the budget, which neglected the sensitivity of spending requirements to economic growth and bond yields. Slower growth would make it harder to reduce the deficit. Tax revenues would fall as the economy runs out of momentum and higher borrowing costs compound the problem.

Markets were already sceptical of the government’s ability to achieve fiscal discipline, while fulfilling manifesto pledges, and not derailing the economy. Recent policy reversals, including on some of the self-imposed ‘non-negotiables’, further put a dent in confidence. The budget will need to balance prudence and ambition to restore credibility, at a time when popularity is at an all-time low.

What to expect in Budget 2025

For global investors, the good news is that UK bonds are not a major part of a portfolio, and sterling weakness is a net positive for overseas returns. However, not all individuals are in the same position and if you have any concerns over how currency will impact you, please get in touch with your Davy UK Wealth Manager.  

For many individuals the biggest impact of the Autumn Budget is likely to be found in the tax regime. Whatever the expectation, it’s wise to wait for the full details of the Budget and seek advice before making major financial decisions.