Rachel Reeves has been warned an extra £9bn of tax rises may be required to avoid a fresh austerity drive in key public services as her record tax-raising budget sent tremors through the financial markets.
Threatening to undermine the chancellor’s claim that her budget would restore economic stability to Britain, government borrowing costs rose sharply in the City on Thursday as traders turned on Reeves’s tax and spending measures.
On a day of wider losses in global markets, the negative reaction came despite the International Monetary Fund lending its backing to the first Labour budget in 14 years as the government sought to defend its plans.
The yield – in effect the interest rate – on benchmark 10-year government bonds jumped to the highest level this year, rising by more than 0.15 percentage points to above 4.5% on Thursday, before falling back slightly by the evening. The higher the yield, the more the government has to pay to borrow money.
City traders warned the higher short-term borrowing levels set out in the budget threatened to derail the Bank of England from pushing ahead with a deep round of interest rate cuts. The pound also fell against the US dollar to its lowest for two months.
Some analysts sought to draw comparisons with Liz Truss’s mini budget, when financial markets were thrown into a tailspin, although they cautioned that the gyrations in the City were far less substantial this time. Others said there were dangers in holding the budget in proximity to a closely-fought US election, amid a febrile backdrop for a historic tax and spending package.
Jonas Goltermann, deputy chief markets economist at the consultancy Capital Economics, said the fallout from Reeves’s budget was “still a very long way from the 2022 ‘mini-budget’ debacle,” but that the similarities could trigger alarm bells in Westminster.
“A meltdown of similar proportions remains unlikely, but plainly investors are nervous about the fiscal outlook in the UK (and elsewhere),” he said.
On Thursday night, the Bank and the Treasury were understood to be on high alert monitoring the situation, while Reeves gave an interview to the financial media news service Bloomberg, insisting to investors Labour’s “number one commitment” was to economic and fiscal stability.
“We have now put our public finances on a stable and a solid trajectory,” she said.
With the government under pressure to defend the budget as financial markets turned against the chancellor, Jeremy Hunt, her opposition counterpart, said that the market reaction showed Britain was “already paying a price” for Labour’s extra borrowing.
“[This will mean] more expensive mortgages and higher debt interest payments for taxpayers. If you preach stability you should practice it,” he said.
Much of the impact for households and businesses will depend on whether the financial market reaction is sustained. Should the rise in borrowing costs persist, with the Bank of England keeping rates higher for longer, high street lenders who use money market rates to price their loans could push up the cost of mortgages.
The Bank is expected to cut headline interest rates from 5% to 4.75% when its policymakers meet on Thursday next week. However, City investors said the central bank could stop short of reducing its base rate to below 4% by the end of next year, a higher level than previously anticipated, in light of Reeves’s budget.
Leading economists questioned whether Reeves’s £70bn package of additional spending measures – with about half backed by the biggest round of tax rises in a generation – would be enough to reboot growth while returning the government finances to a stable footing.
Paul Johnson, the director of the Institute for Fiscal Studies, said that although Reeves had made a substantial downpayment to halt an “unrealistic” and reckless course plotted by the Conservatives, more action would be required.
Casting doubt on Labour’s claim to be turning the page on austerity, the IFS said Reeves could be forced to top-up her spending plans by an additional £9bn after the next financial year to avoid ushering in real-terms cuts to unprotected Whitehall departments, including councils, the justice system and prisons.
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Britain’s leading experts in the public finances said the chancellor’s plans amounted to “pretending” that the government would splurge in the early years with a generous funding settlement, before reining in spending in future.
“That’s not going to happen. The spending plans will not survive contact with her cabinet colleagues,” Johnson said.
Despite plotting a course of higher spending, tax increases and borrowing, experts also questioned whether the chancellor had done enough to mend public services and raise living standards in a way that would be meaningfully felt by voters before the next election.
The Resolution Foundation said the budget had not yet delivered a “decisive shift away from Britain’s record as a ‘stagnation nation’,” with a weak growth outlook for living standards across the rest of the parliament.
“The short-term effect of these changes will be better-funded public services – not just across schools and the NHS – but, critically, also in our justice system. But families are also set for a further squeeze on living standards as the rise in employer national insurance dampens wage growth,” said Mike Brewer, the thinktank’s interim chief executive.
On Thursday, Number 10 hinted that it hoped growth forecasts would improve during the course of the parliament once further policies including planning had been spelt out and could be scored by the OBR.
“This is not the limit of her ambitions when it comes to growth,” Starmer’s spokesperson said. “The OBR figures don’t take into account a significant range of other reforms that the government’s undertaking, whether it’s planning reform, reforms of the skills system … this is not the limit of our agenda on growth. Do we want to see higher growth figures … to bring in the revenues to fund our public services, yes, but yesterday was a start.”
No 10 also hit back at some of the criticism of future tight spending plans. “Over the course of this parliament, public spending has grown significantly faster than spending plans that this government inherited,” the spokesperson said.
“It is precisely because the government inherited spending plans that didn’t add up from the previous government that the chancellor had to take difficult decisions yesterday to fix the foundations and put more money into our public services, and that’s why you can see over the course of the parliament, day to day funding will now grow an average of 2% a year in real terms, which is obviously significantly higher than the spending plans that this government inherited.”