Reeves’ risky borrowing policies prompt fresh tax hike fears
Tax hike fears are gathering pace as rising borrowing costs are set to wipe out around half of Chancellor Rachel Reeves’ small £9.9bn headroom, a leading economics consultancy has warned.
Reeves made around £14bn in spending cuts at her Spring Statement two months ago but left herself with one of the slimmest fiscal buffers on record.
Fresh calculations suggest Reeves may have to make more radical cuts in the coming months if she wishes to stick to her strict fiscal rules, under which the public budget must be in balance or surplus on a three-year rolling target.
Oxford Economics’ Andrew Goodwin has estimated that around £4.5bn of the headroom pencilled in the final year of the Office for Budget Responsibility (OBR)’s forecast will be eradicated if gilt yields, which affect debt interest payments, stay at their current level and two more interest rate cuts are made this year.
Gilt yields are 20 to 25 basis points higher than they were for the spring statement forecasts and market expectations for Bank Rate are “a little higher,” Goodwin told CityAM.
“Obviously, it’s a long time to go before we get to knocking the assumptions for the budget, but if they stay where they are now, then you’re looking at wiping out half the headroom.”
Reeves may ‘need to increase’ taxes or cut spending
Shaky market prices in the US are also affecting gilt yields in the UK, making policymaking in Britain “very hard” given President Trump’s flip-flopping over tariffs and other key state spending measures, according to
The latest episode saw credit ratings leader Moody’s follow S&P Global Ratings and Fitch Group in downgrading the US one level from a triple-A rating.
Analysts at Moody’s sounded the alarm on surging government debt levels and a deeper budget deficit, claiming “successive” presidential administrations had failed to “reverse the trend of large annual fiscal deficits and growing interest costs”.
JP Morgan chief executive Jamie Dimon accused investors of becoming “complacent” after the S&P 500 barely moved after the downgrade was revealed.
The initial rise in Treasury yields was followed by a rise in UK 30-year yields, which peaked at nearly 5.5 per cent before falling back.
According to Ben Nicholl, a senior fund manager at Royal London Asset Management, investors were worried about the level of gilts being issued as well as the high level of interest rates set by the Bank of England.
The spending review, which is due in the summer and could signal whether Reeves is prepared to make drastic cuts to public spending, was the next indicator of whether the Chancellor was serious about lowering the national debt and keeping her small headroom intact.
Should cuts not be made, tax rises would appear more likely, Nicholl suggested.
“The market is telling the Chancellor that £300bn of gilts [being issued] this year, plus what we’ve got to come over the next few years is a lot for the bond markets to take on,” Nicholl told CityAM.
“[The government is] going to need to reduce spending, or they’re going to need to increase taxes. So, there is some work for the Chancellor to do there.”
Oxford Economics’ Goodwin said Reeves’ “risky” gamble in setting herself a small headroom was “not paying off at the moment” as her headroom looks set to get wiped out, adding that manifesto pledges not to raise income tax, VAT or national insurance for workers put the government in a corner.
“It’s more that they’ve promised not to increase so many different taxes that it’s going to be very difficult to avoid going back on one of those commitments,” he said.
“It’s such a large slice of the tax pie that it is meant to be off limits. It doesn’t leave enough left to make any meaningful increases.”
Showdown with ‘moody’ investors
Neil Mehta, a portfolio manager at RBC BlueBay Asset Management, said political tensions around welfare should not thwart Reeves’ commitment to “getting finances in check”.
“The speculation of reversing the winter fuel payment policy announced last year is another example of how political priorities make it hard for the Labour government to get a grip of the scale of the UK’s borrowing needs to stabilise debt levels,” Mehta said.
“Markets are in no mood to give this government the benefit of doubt and continue to attach a higher risk premium to longer dated gilt.”
The National Institute of Economic and Social Research (NIESR)’s interim director Stephen Millard has suggested that gilt yields are “only a little above the OBR’s forecast”, meaning the Chancellor still had some time before focussing her attention on stabilising public finances.