Businesses, Budgets and Beyond: Looking ahead to 2026

Transcript

Simon
Hello and welcome to the third Economics podcast of the year and the final one for 2025. I'm joined by Barret Kupelian, our Chief Economist, and we're going to dive straight in.

We're a number of weeks now past the budget dust has settled on the Chancellor's statement and I think it's useful just to take a bit of a breath and say what are your reflections both actually in terms of the quite unusual run up that we had to the budget this time round, and then on the detail of the statement itself?

Barret
Well, it was a quite leaky budget, and I don't think that was helpful for businesses and consumers just because the speculation about what could happen in the future sort of freezes up spending. So, in some ways when sort of Westminster holds its breath, the rest of the economy does so as well.

And I think we saw that in the run up to the budget and we saw that being reflected in the GDP numbers that came out a few days before.

Now in terms of the content of the budget, the macro content of the budget, I think all the focus was on the headroom. We were in the run up to the Budget anticipating movements on the headroom. Is it going to be thick or thin? And the Chancellor opted for a thicker headroom, which is actually quite good for businesses and for the private sector in general, because it means that the likelihood of having big changes in fiscal policy in the future is actually reduced. And that in turn then means that you, you probably have a bit more certainty in the economy.

Now the second point is around the profile of the budget. So if you take a look at the first couple of years, the first 2-3 years of the tax and spend decisions, you'll see that government spending is increasing materially. In the beginning of the forecast horizon that's funded both by borrowing and additional tax receipts. But then if you go towards the end of the forecast horizon, the additional government expenditure is actually being funded exclusively by taxation, both existing and new taxation.

You know, if you were a cynic, you would say, well most of the new policies are coming towards the end of the forecast horizon, is that credible or not? I think what I would say as a push back to that point is most of the new tax receipts, not all of it, but most of it will be coming through the extension of existing policies, so most of the heavy lifting will be done by the freezing of the personal income tax allowances, so there is an error and degree of predictability and credibility in that.

And the second thing I would say is that we've seen this time and time again, not just in this budget, but in previous budgets as well, whereby historically in the outer years of the forecast horizon, you'd either see tax increases or what we used to see historically is unrealistic spending cuts. So actually the fact that we're seeing an, an extension of existing policies makes it a bit more credible. And I think that was reflected in the financial markets. If you look at the bond yield moments on the day as well.

Simon
I think you're being pretty kind, but saying a lot of the kind of leaks created quite a lot of uncertainty and unsettled feeling across businesses and probably didn't help the run into Christmas retail spending that we often see. But actually, the thick headroom, I think that's the way you described it actually now sets us on a much more stable course in terms of the fiscal arithmetic for the remainder of this Parliament.

And if we, if we drill in then to the, to the business implications, what do you think businesses are now going to be thinking? And what are the key issues for businesses are as they wrap up 2025 and focus on 2026?

Barret
If you take a look at the changes, both in terms of tax and non-tax policies that businesses have been subject to in the past 12 months, they've been quite a lot. The headline one is the increase in the National Insurance contribution by employers. The second bit that we saw in this budget is the changes announced to business rates, which actually disproportionately effects some segments of the economy than others.

And then there's a couple of other things that are in the pipeline. The first one is the increase in the national living wage, which is announced the day before the budget. And by April of next year, the National Living Wage will have gone up by cumulative 11% over 2 years. So that's a big change for some of the low wage sectors of the economy and businesses will need to adapt there.

And then finally, the last change that's coming through, which is a non-tax one is the employment rights bill. That will be subject to multiple consultations and it will be quite interesting on what form of unemployment rights bill we end up with at the end of it.

Simon
And just touching on that here, it's really interesting you've hit on a couple of points there linked to employment, labour market, levels of employment and unemployment. We've recently had employment data through up to the end of October and that showed a little bit of an uptick, and with that increase in the living wage and with the Employments Rights Bill, are we in a situation here where actually some of the government's policies are starting to take some heat out of the labour market?

Barret
We've seen that being reflected in the aggregate vacancy numbers definitely. And you're right to say that the trajectory for the unemployment rate is slightly ticking upwards. You know, unemployment is a lagging indicator of economic development so that's part and parcel of that effect.

But overall, I would say that labour is now more costly to employ compared to three years ago and businesses are in turn adjusting their strategies there depending on which sectors they are and how intense labour is in their production process.

There are also some stresses and changes being recorded in specific segments of the labour market. We recently released our Youth Employment Index and one of the questions we tried to answer in that report is whether the take up of AI tech is actually affecting the labour market in aggregate.

And the short answer is no; it's not affecting it on aggregate based on the current data. But actually if you could some segments and sectors of the economy we are seeing some changes.

Simon
So we're starting to see this lead indicators come through. I wonder if we just shift the conversation on to broader predictions for 2026. So what's the time of the year when, when people do that?

And I know every year we put out PwC’s economic predictions for the year ahead. So what are you, what are you your kind of top, top thoughts and themes?

Barret
So let me take out my crystal bowl and tell you what will happen with 100% certainty. Joking aside, I think if we start off with the largest economy in the world, the United States, I think there's three things I would be watching out for there.

The first one, and we might see developments on this even right after this podcast is released in the public domain is on who will be the, the Federal Reserve's new chair. And that's really important for the US and the global economy because we might see snippets of whether there will be changes in the monetary policy in the US or no.

The second one is with respect to tariffs in the US. In April of this year, we had Liberation Day and triple digit headline tariff rates were announced. But if you look at effective rates, they're much lower than that because they've been quite a lot of exemptions, they've been trade agreements being agreed and so on and so forth. And if you look at the trade data, US imports from China are going down in absolute amounts.

So, you know, in terms of policy objectives achieved, you've, you've got a big green tick there. But if you look at US imports from the ASEAN economies or the Southeast Asian economies, those has actually been going up, which sort of goes against this policy of reducing trade deficits.

So, you might see some movements there. And then the third point is with respect to AI and whether the valuations of these big conglomerates are relevant currently. We could see some movements there, but that will, I suspect be purely financial rather than speculation as to whether the technology works or not.

Simon
Where do you stand on the risks of a of AI market reset? Do you think we're likely to see a pretty sharp revaluation of stocks in UK, US, Europe in the first quarter or first half of next year?

Barret
You could see a revaluation, a financial revaluation, I suspect of some of these large AI entities. And the main reason for that is because artificial intelligence is a generally newish technology. So fully understanding what the revenue flows and the cash flows will be in the future is subject to a degree of uncertainty.

But I think if you look at the core of it the, and by that, I mean the technology itself, whether it works or not, whether you can apply in different sectors of the economy, I'm much more comfortable about the applicability of that technology in the future. I think there's, there's really big scope of applying the technology.

It's just that now we're trying to figure out how we can apply it in our day-to-day lives, a bit like we still do with Internet and the Internet is a relatively old technology.

Simon
And then I need to ask you this final question, which is we, we've got a government that came into power with a very clear manifesto pledge to have the fastest growing economy in the G7.

How do you think we've been set up over this first kind of 18 months or so of this government to kind of cash in on that to manifesto pledge?

Barret
Well, interestingly, I think you might be seeing some of the effects from the very first budget from last year starting to materialise in the numbers. I think in the first budget that we had when this government came to power, one of the things we had was a change in the fiscal rules and the fact that public investment was protected. And if you look at the profile of public investment, that will take an uptick starting from next year onwards and we should be seeing that potentially crowding in some private investment as well.

I think point #2 is you will probably be seeing a re-evaluation of the relationship between the UK and the EU. We've got the trade and cooperation agreement that's been up for renegotiation, so you might see some sort of developments, for example, in the food and agricultural sector, which might help food inflation.

And then the third point I think is assuming we've got a degree of stability, you will start seeing hopefully some certainty coming through from the private sector in additional spending and that's the base case scenario.

Simon
And final question and final question for the 2025 podcast, maybe leave us on an optimistic note. What do you think the likely growth number is going to be in the UK next year? And which of the sectors that are really going to power that?

Barret
I think the sectors that will probably prove to outperform the rest of the economy will be the defence sector and the security sector. I mean, that's a pretty consistent theme we're seeing across not just in the UK, but in Europe as well.

I think the second sector that we'll be seeing more developments in is the “making stuff” sector, such as manufacturing, semiconductors and so on and so forth. I would incorporate infrastructure spending under that that banner and headline.

The third one I think is affordable retail. I think we are still reeling from the side effects of the cost-of-living crisis and households seem to be going for sectors that provide value for money.

And then finally, I think from a business perspective, sectors of the economy that help businesses enhance the use of labour. So that could be anything from AI or through any other productivity enhancing improvements as well because at the end of the day, businesses are trying to protect and ultimately grow their margins at a time when labour cost is increasing.

Simon
And final question, GDP forecast for the year?

Barret
I would say between 1 and 1 1/2 percent close to potential.

Simon
Brilliant. Barret, thank you very much for your insights. As ever, we will look at your crystal ball predictions as we go through next year and see how accurate we were.

Have a fantastic Christmas and to all the listeners as well and we'll be back with more insights in 2026.

Thank you.