The new year may have rustled up some surprise stand-offs for the Labour government (mainly calls from X founder Elon Musk for Keir Starmer to resign), but the rise of new problems does not mean the old problems have disappeared. A harsh reminder has been dished out this morning, as long-term borrowing costs reached a 27-year high, calling into question yet again exactly how the Treasury is going to make good on its spending commitments while sticking to the Chancellor’s own fiscal rules.
Thirty-year gilt yields hit 5.21 per cent this morning – a level that surpasses the surge in borrowing costs following Liz Truss’s mini-Budget in 2022. The ten-year gilt is now parallel to the peak reached under Truss, too. Both then and now, these increases suggest a deep worry on the part of investors that the UK’s economic trajectory is not as rosy as the Labour government suggests it will be by the end of its first term.
It doesn't help that the economic news since the Budget has not been positive: the UK economy contracted slightly in both September and October last year. The monthly inflation rate, while still not far off the Bank of England’s 2 per cent target, has been coming in higher than expected, increasing concern that the public sector pay raises confirmed over the summer may lead to a second round of price hikes.
While the details of the Budget were announced over two months ago now, it’s thought that the impacts of the measures have only just started to be felt. It’s expected that some businesses will change their hiring habits this year, to deal with the NI rises. As reported yesterday on Coffee House, business confidence is at a two-year low, with a record number of businesses telling the British Chamber of Commerce that they are worried about the tax they have to pay – a concern driven upward by the employer National Insurance hike which kicks in this spring.
All this suggests the UK will remain stagnant – or in the worst-case scenario, experience another mild recession. Prolonging the UK’s low-growth cycle into a second decade has immense repercussions for businesses and workers – further denying opportunities and prosperity that would come if the economy were stronger.
There are serious ramifications to all this for the Treasury. Even the additional £40 billion in tax increases announced in the government’s first Budget are not going to be enough to sustain the government's spending pledges, if growth figures fall notably short of the (already fairly weak) figures forecast by the Office for Budget Responsibility. If borrowing costs continue to hover at these highs – or indeed rise further – Rachel Reeves could get uncomfortably close to breaking her own borrowing rules, having left little fiscal headroom for herself in the Budget.
That borrowing costs have been on the rise since the Budget began to be briefed in September – and haven’t come back down – means it’s very likely Reeves will have to dish out more on borrowing costs (that’s payments for money already spent) than she first anticipated, especially if interest rates don’t fall as quickly as once hoped.
This means less money for spending on the government’s much-anticipated projects – or another round of significant tax hikes. The government can try to hold out for that much discussed ‘growth’ – but there isn’t much time. Soon the Spending Review will take place and the Chancellor will have to decide which path she wants to take.
Katy Balls, Kate Andrews and James Heale unpack the challenges facing Rachel Reeves in the latest Coffee House Shots podcast:
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