UK chancellor Rachel Reeves flew home from China yesterday (a controversial trip in the first place) to the biggest fiscal crisis since former British prime minister Liz Truss’s ill-fated mini-budget in 2022 and the biggest one her incumbent Labour Party administration has yet faced.
The yield – in effect the interest rate – on UK government bonds, known as gilts, rose to a 16-year high last week as investors fretted about the Labour government’s heavy borrowing needs and the renewed threat of stagflation (when inflation combines with lower growth).
Reeves signalled last year that she intended to borrow billions in additional money to invest in Britain’s ailing economy, which has been flagging since the 2007-09 global financial crisis and in the wake of recent shocks from Brexit, Covid and soaring energy prices.
However, her government’s increasingly fragile financial position is now caught up in renewed global concern about inflation, which could, in theory, be reignited by tariffs in the US, which incoming US president Donald Trump plans to impose on imports.
This would have the effect of raising interest rates or at least keeping rates higher for longer, a negative for heavily indebted countries like the UK.
Economists have warned a sustained rise in borrowing costs could sweep away a £10 billion buffer that Reeves had kept in reserve at the autumn budget to meet her primary fiscal rule, which requires day-to-day spending to be matched by tax receipts.
A spending review, due later this year, is already expected to require UK government departments to make efficiency savings worth 5 per cent of their budgets.
But with more money having to be spent on servicing government debt, that figure could end up being even higher, given Reeves has previously ruled out further tax rises.
Either way, Reeves has a difficult job ahead of her.
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