The increase in UK borrowing costs since last week’s budget has wiped out all of Chancellor of the Exchequer Rachel Reeves’ headroom against her main fiscal rule, raising the prospect of further tax rises or spending cuts unless the debt picture changes.
Tom Josephs, a senior member of the UK’s fiscal watchdog, told lawmakers Tuesday that a 0.3 percentage point rise in government borrowing costs would eliminate all of the £9.9 billion of space against Reeves’ “current budget” rule that day-to-day spending must be paid out of tax.
The market selloff after traders were surprised by the scale of extra borrowing set out in the budget has pushed the yield on five-year gilts 0.3 percentage points above the forecast by the Office for Budget Responsibility, according to Bloomberg Economics analysis. Expectations for Bank of England interest rates are half a percentage point higher.
That would leave the chancellor needing to raise funds were nothing to change before her budget next year.
Reeves unveiled £142 billion of extra borrowing, much of it front-loaded, and left herself very little room to deal with any shocks. A weak growth forecast from the OBR, which also warned that her policies would be mildly inflationary, compounded market concerns. Ten-year UK government borrowing costs, which move inversely to prices, are now the highest they have been in a year.
OBR Chairman Richard Hughes told MPs he had “expected the budget to be a surprise to the markets just because of the volume of gilt issuance.” The OBR added a quarter percentage point to its interest rate forecast in anticipation of the market reaction, he said, but the market has moved even further.
As well as her “current budget” rule, Reeves left herself very little room against her debt rule that requires “public sector net financial liabilities” to be falling in five years. The target is hit with just £15.7 billion to spare.
The narrow fiscal space on the debt rule was partly related to an error by the OBR, which had overestimated PSNFL by £18 billion for the previous Conservative government’s final budget in March.
Hughes told the House of Lords Economic Affairs Committee at a separate event Tuesday that the OBR “realized this error several months ago” and gave the Treasury “a re-based forecast” long before Reeves’ budget on Oct. 30.
He said it was a “spread-sheeting error” made because PSNFL was of almost no interest to policymakers until Labour chose to replace the previous debt measure with it for her second fiscal rule. Josephs told lawmakers on the Treasury committee that PSNFL is an unusual fiscal metric to use. “I’m not aware that other countries use that measure,” he said.
Reeves changed the debt measure because PSNFL gave her more room to invest, and she unveiled an extra £100 billion for public capital projects.
Hughes insisted that the OBR’s failure to alert the market to the error ahead of the budget was not to blame for the negative financial reaction.
“I have not picked up in our discussion with market participants that the correction of this error made much of a difference to their view of the sustainability of the public finances,” he told peers.
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