UK sentiment rebound helps, but gilts and sterling still need Budget credibility

UK business confidence has recovered to its strongest level since March, giving the new Burnham government a more favourable growth backdrop as Parliament returns. But the improvement is unlikely, on its own, to drive a sustained rerating of UK risk assets while investors continue to price sterling, gilts and Bank of England expectations against fiscal credibility.

Lloyds’ August Business Barometer rose four points to 53%, above its 12-month average of 47%. Economic optimism climbed seven points to 49%, while firms’ own trading outlook stood at 58%. The most market-relevant detail may be disinflationary: the share of companies expecting to raise prices over the next 12 months fell three points to 51%, the lowest since 2022.¹ For UK equities, stronger demand alongside softer price intentions is close to the ideal survey mix.

Yet sterling ended the week under pressure. Reuters reported that the pound was on course for its first weekly decline against the dollar in more than a month, as investors pared expectations for a BoE rate increase this year and awaited fiscal signals from the Andy Burnham-led government before October’s Budget.² That price action captures the current hierarchy for UK assets: better activity data can help, but policy risk is still setting the discount rate.

A better growth signal, not a fiscal free pass

The Lloyds survey matters because it pushes back against the most bearish domestic narrative. Confidence improved for a second consecutive month, domestic firms posted a 10-point gain, and services confidence reached a 13-month high.¹ If that translates into investment, hiring and resilient consumer demand, it could support domestically exposed mid-caps, banks and retailers more directly than the internationally weighted FTSE 100.

It also gives Chancellor John Healey a marginally better backdrop for the first Budget. Stronger sentiment raises the possibility that tax receipts and nominal activity can do some of the work that spending cuts or tax rises would otherwise need to do. But the fiscal challenge remains material. The Guardian reported that Rachel Reeves left £23.6 billion of headroom in her last Budget, while higher inflation and borrowing costs are likely to erode that buffer.³

That is why investors should treat the survey as a cyclical positive, not a regime change. The gilt market will judge whether the government uses stronger sentiment to reinforce fiscal discipline or treats it as room for additional commitments. Budget speculation around capital gains tax illustrates the tension: The Independent reported warnings that a higher CGT burden could deter asset sales or shift capital abroad, potentially lowering rather than raising revenues.⁴

The gilt market is the transmission channel

For rates investors, the problem is that confidence data and fiscal risk pull in different directions. Better business conditions can lift real growth expectations and reduce recession risk. But if the same backdrop encourages looser fiscal choices, term premia can stay elevated.

The UK 10-year yield was listed at 5.303% on MarketScreener’s delayed data as of August 29, with the page showing a positive year-to-date move.⁶ DividendData’s gilt table showed a materially upward-sloping long end, with several conventional gilts from the mid-2030s onward yielding around or above 5%, and selected 2054 maturities yielding around 5.8%.⁷ Real yields are also high by post-financial-crisis standards: index-linked gilts maturing in the 2040s and 2050s were mostly shown around the mid-2% area.⁸

Those levels matter for equities. A higher risk-free rate compresses valuation multiples, raises corporate funding costs and makes dividend yields less compelling. It also affects banks and insurers in more complex ways. Higher long rates may support reinvestment income, but fiscal volatility can widen credit spreads and pressure capital-sensitive financials.

The FTSE 100’s recent resilience is therefore not a clean read-through from domestic confidence. A market report put the index at 10,812 after a 20-point gain and noted that investors were waiting for the first Burnham Budget, expected on October 28.⁵ Because the index earns much of its revenue overseas, sterling weakness can flatter translated earnings even when domestic policy uncertainty is rising.⁵

Sterling is caught between the BoE and the Budget

The currency market is where the trade-off is most visible. Reuters said sterling’s losses were driven partly by dollar strength and by investors trimming BoE hike bets, with December pricing falling to about 25 basis points of hikes from roughly 30 basis points a week earlier.² The same report said markets were waiting for fiscal clues as Parliament reconvenes and quoted analysts arguing that the BoE may wait for the Budget before adjusting its policy stance.²

The Lloyds pricing data should, at the margin, reduce concern that corporate price-setting is becoming entrenched. If fewer firms plan to raise prices, the BoE has less reason to lean hawkish solely on second-round effects. But energy costs, geopolitical risk and fiscal policy can still complicate the inflation outlook. The Guardian linked the fiscal backdrop to the Middle East conflict, inflation and borrowing-cost pressures, while Reuters noted elevated energy prices as part of the market environment.³²

Global rates also matter. The Jackson Hole backdrop has kept investors focused on central-bank reaction functions, with AP reporting that Federal Reserve Chair Kevin Warsh used the conference to shape expectations around inflation, data and the next policy meeting.⁹ For sterling, even a constructive UK survey can be overwhelmed if US rates, dollar strength or global risk appetite move against it.

What UK investors should watch next

The key question is whether the Budget converts improving sentiment into a credible medium-term growth plan. A market-friendly outcome would pair targeted growth measures with a believable borrowing path, avoiding unfunded giveaways and minimising tax changes that deter investment. That could allow gilt yields to stabilise, sterling to find support and domestic equities to reprice better activity data.

The risk scenario is different. If investors see stronger confidence as political cover for looser fiscal policy, long-end gilts may remain under pressure and sterling may struggle even if surveys improve. In that case, higher discount rates would cap equity upside, particularly in rate-sensitive property, utilities and domestic cyclicals.

For now, Lloyds’ Business Barometer is a genuine positive. It suggests UK companies are seeing better demand and less need to lift prices. But for UK rates and equity investors, the decisive test is still ahead. Confidence can improve the starting point; fiscal credibility will determine whether markets are willing to pay for it.

UK sentiment rebound helps, but gilts and sterling still need Budget credibility

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A better growth signal, not a fiscal free pass

The gilt market is the transmission channel

Sterling is caught between the BoE and the Budget

What UK investors should watch next

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