Market News

A leading City research firm has slashed its forecast for UK growth next year by two thirds from 1.5% to just 0.5% because of the impact of a likely income tax bombshell hitting pay packets next April.

US owned Morningstar said it had cut its GDP forecast for 2026 so deeply because “an expected income tax hike is set to weigh on economic growth.”

Its UK economist Grant Slade said growth could grind almost to a halt in the first half of next year as consumers wind in their spending in anticipation of higher income tax bills from April onwards.

He expected some pick up later in the year when further interest rate cuts lift some of the pressure off disposable incomes. Morningstar is now predicting growth of 1% in 2027 compared with 1.5% in its previous forecast in March.

Slade said: “We think that tax hikes are coming, probably on income tax and as a result consumption will take the hit next year. Growth will fall from 1.5% this year to 0.5% next year and that will mostly the result of the income tax hikes if they come. We will start to see a gradual recovery in 2027 with 1% growth before heading back to trend GDP growth in 2028.”

However, he said the Bank of England will be faster to cut interest rates than markets currently expect with the cost of borrowing down to just 2.5% by mid 2027.

Rachel Reeves is now widely expected to announce an income tax hike of up to 2p on the basic rate in her Budget speech on November 26. She will become the first Chancellor since Denis Healey in 1975 to deliver an increase in the basic rate.

The Chancellor needs to raise an estimated £30 to £40 billion to meet her “iron clad” fiscal rules and give herself a more comfortable headroom buffer against future economic setbacks.

The Treasury hopes that will comfort jittery investors who currently demand a premium to buy the Government bonds - or gilts - that have to be sold by the Government to pay for public spending.

In her unconventional pre-Budget speech earlier this week Reeves refused to rule out tax rises, pledged there would be no return to austerity and said she will make the "necessary choices" to prioritise growth and fairness.

The speech was widely interpreted in the City as preparing the ground for the first hikes in the basic rate of income tax for half a century.

The new rates are likely to come into effect at the start of the new tax year on April 6. A 2p rise would raise around £20 billion a year. It would cost a typical London worker on a salary of £50,000 an extra £748.60 a year, or £62.38 a month, in extra tax. A higher earning worker on £80,000 would see take home pay fall by £1348,60 a year or £112.38 a month.

However, it is possible these increases in income tax could be partially offset by a cut in employee National Insurance rates.