Chancellor Rachel Reeves oversaw lower government borrowing than expected in July, official data has revealed, even as fiscal watchdogs warn of mounting pressures that could see public debt triple to 270 per cent of GDP within 50 years.
Borrowing hit £1.1 billion last month, making up the difference between income from taxes and total expenditure, according to the Office for National Statistics (ONS). Government borrowing was £2.3 billion smaller than at the same time last year, coming in below the fiscal watchdog’s prediction of £2.1 billion for the month.
The relatively positive July figures stand in stark contrast to June’s borrowing of £20.7 billion, which was up by £6.6 billion compared to the previous year. In more worrying signs for bond traders, public debt has increased over the last year to 96.1 per cent of UK GDP.
The temporary respite comes as the Chancellor faces an unprecedented fiscal challenge. The Office for Budget Responsibility warned in July that public debt could rise from its current level of 95 per cent of GDP to 270 per cent of GDP in 50 years, based on current policy settings and demographic projections.
“The UK cannot afford the array of promises that it has made to the public,” said Richard Hughes, chair of the fiscal watchdog. The OBR’s damning report suggested Britain could not afford the triple lock pension whilst problems in balancing the costs of net zero with the impacts of climate change would further deteriorate public finances.
The triple lock, which guarantees state pension rises by the highest of inflation, wage growth or 2.5 per cent, has cost three times more than initial expectations, costing £15.5 billion annually rather than the projected £5 billion. State pension spending alone could increase to 7.7 per cent of the UK economy by the early 2070s, up from five per cent currently.
Politicians can not afford the array of promises they make to voters in successive elections,” Hughes warned, as the OBR projected that without policy changes, public spending would rise from 45 to over 60 per cent of GDP over the next 50 years, whilst revenues remain at around 40 per cent of GDP.
The more imminent threat to public finances has been sounded by several forecasters in the City. The National Institute of Economic and Social Research (NIESR) suggested that the government faced having to fill a £50 billion black hole with higher taxes due to lower growth forecasts, policy U-turns and the threat of borrowing costs inching higher.
“The chancellor faces an impossible trilemma: it is becoming increasingly difficult to see how the Government meets its fiscal targets, sticks to spending promises, and avoids tax increases on working people. Something will have to give,” said David Aikman, director of NIESR.
Stephen Millard, NIESR’s Deputy Director for Macroeconomics, added: “All forecasts are wrong, we know that. But I’m fairly convinced that there’s a sizeable gap the chancellor will need to fill. It might not be £50 billion – it could be £40 billion.”
Other City analysts have indicated that at least £10 billion in taxes will have to be raised later this year. Hiking taxes on property, pensions and businesses are among a number of options available to the Treasury, but government officials are fearful of making unpopular decisions.
Bond markets rang alarm bells this week as long-term gilt yields inched up, pushing borrowing costs higher. Various major economies are suffering from a lack of trust from traders across the world whilst quantitative tightening has also taken its toll on costs to the Treasury.
The UK’s long-term gilt yields have been higher than that seen for US government bonds when, previously, they have moved in a similar pattern, suggesting the risk premium on the UK is higher. Ten-year gilt yields rose to around 4.5 per cent in recent weeks, with 30-year yields climbing even higher, reaching levels not seen since 1998.
“Higher borrowing can also push up the market cost of new debt issuances,” warned Moody’s in a recent report. “We expect financial markets to remain more sensitive to the potential for UK policy missteps, because of the gilt market turmoil that followed the September 2022 mini-budget.”
The OBR on the state of the UK economy is set to make the final judgment at this year’s Autumn Budget, with Reeves facing pressure to either raise taxes, cut spending or rewrite her “iron-clad” fiscal rules. Labour’s 2024 manifesto promised no tax rises for “working people” and no increases to National Insurance, or the basic, higher or additional rates of income tax or VAT – a pledge that NIESR believes is no longer sustainable.
In October’s budget, Reeves unveiled £40 billion of tax rises, including a hike in employer National Insurance contributions, to address what she called a £22 billion “black hole” left by the previous Conservative government. The OBR revised its growth forecasts following the budget, expecting UK real GDP growth of 1.1 per cent in 2024, followed by expansion of 2 per cent in 2025.
Despite these measures, the fiscal challenges remain daunting. Net debt interest spending is expected to cost £111.2 billion in 2025-26, representing 8.3 per cent of total public spending and equivalent to over 3.7 per cent of national income. The OBR warned that a one percentage point increase in gilt rates would increase debt interest payments by £12 billion by the end of the forecast period.
The government’s finances have emerged from successive shocks under strain, with deficits averaging just under 5 per cent of GDP since the start of the century. This has caused debt to more than triple as a share of GDP to 98.1 per cent by March 2024, its highest level since the early 1960s.
As Reeves prepares for future fiscal events, she faces what analysts describe as “unenviable decisions” about how to restore sustainability to the public finances whilst maintaining essential public services and meeting the government’s growth ambitions.
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Image Credit (Shortened):
Chancellor Rachel Reeves delivers the “Fixing the Foundations” press conference at HM Treasury (29 Jul 2024) – by Zara Ferrar / HM Treasury, licensed under OGL v3.0, via Wikimedia Commons.
