The UK government has been in something of a bind. As the cost of its borrowing has risen since the autumn, the chances of meeting its main self-imposed fiscal rule — to borrow only for investment by the end of the decade — have dwindled. The setback has been met with fierce rhetoric from the government. Whether from Prime Minister Sir Keir Starmer, Rachel Reeves, his chancellor, or their spokespeople, the adjectives to describe the fiscal rules have tended to shuffle between “ironclad” and “non-negotiable”. Their attitude is always “absolutely committed”.
Sentiment has improved in UK government bond markets over the past week, but many are yet to be convinced. Ray Dalio, the billionaire founder of hedge fund firm Bridgewater Associates, is less than impressed, saying that gilts could be heading for a “death spiral”. Of course, this was overblown, but his comments reflect a broader concern in financial markets that a gap exists between tough fiscal rhetoric and the reality of UK budgetary policy — and it far precedes the current Labour government.
What is needed to provide the budgetary stability on which the rest of the UK economy can build is therefore simple. No more rhetoric. No more announcements of tighter fiscal policy either now or some time in the future. Instead, Reeves needs to implement the tax increases and spending plans outlined in October without any compromise on when they are due to come into force in April.
These are sizeable. Along with the large and messy increase in employers’ national insurance, there are continued income tax rises in the form of frozen allowances and far from lavish public expenditure increases. Together, the measures are set to reduce government borrowing significantly. The overall deficit is forecast to fall from 4.5 per cent of GDP in 2024-25 to 3.6 per cent in 2025-26, while the current budget deficit, excluding capital investment, is set to halve from 2 per cent of GDP to 0.9 per cent over the same period.
This will be an exercise in show, not tell. Reducing borrowing by this much is reasonably rare for UK governments — it will become clear by the summer whether Reeves and her policies are on track. Success would immediately demonstrate a difference between UK fiscal policy and that of similar countries.
In recent years, US administrations have shown no ability to run a deficit much under 6 per cent of GDP, and there’s no improvement in sight. The European Commission expects the French budget deficit to have exceeded 6 per cent of GDP last year, with little prospect of a political agreement to deliver much improvement. Underlying German public finances are strong, but its economy is weak. And debt levels in the UK, though high, are still far lower than those in Italy.
Bond markets often have a mind of their own, but it would be difficult to single out the UK for special punishment if it is the one decent-sized advanced country with the ability to pass legislation to impose fiscal consolidation and actually see it through. This is what Reeves must do. If growth suffers, the Bank of England would be in a strong position to ease monetary policy and offset the fiscal tightening.
There are no guarantees in the business of persuading financial markets that they have more to lose if they bet against you. The UK government must also hope that consumers begin to spend their recent real income gains and improve growth. It needs to demonstrate that any expansion will come with some recovery in productivity growth. And that the increases in employers’ national insurance must not have a much more damaging impact on jobs and prices than already expected.
None will be achieved with more speeches about non-negotiable commitments to ironclad fiscal rules.
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