Rachel Reeves quickly disappeared in amid higher borrowing costs, stubborn inflation, slow economy and hopefully finding billions of pounds of defence spending.
The Prime Minister will receive a final ruling from the Office of Budget Responsibility (OBR) ahead of a spring statement on March 26 on whether her fiscal rules have been destroyed by increasing financial pressure since last fall.
Reeves will return to bad news after a whistle tour in South Africa after meeting with the G20 Finance Minister earlier this week to highlight the importance of increasing defense spending.
The final “predictive forecast” of OBR will be key as it will indicate how much headroom (if any) the Prime Minister leaves in her self-imposed fiscal rules. So this will support any action she must take. Reeves’ policy decisions will then be incorporated into the final economic and fiscal outlook report released along with the Spring Statement.
What happened to the Prime Minister’s clearance?
Back in October’s budget, Reeves deducted £9.9 billion in headroom to resist her main fiscal rules – requiring matching tax revenue in the fifth year of the forecast.
However, government borrowing is more than OBR predicted, and the cost of debt services in the UK has risen sharply in the financial market.
Capital Economics analysts expect this could reduce the prime minister’s net shortage from £9.9 billion to £2.8 billion. However, there are other factors that affect the assessment of OBR.
Economy under pressure
The UK economy grew weaker than October’s forecast, narrowly avoiding a recession in the second half of 2024. OBR is widely expected to almost halve the growth rate in 2025, with a close-range forecast of nearly 1%. Apart from the rising borrowing costs, analysts say a weaker growth outlook could eliminate the prime minister’s headwind.
The Bank of England highlighted the danger after reducing its GDP growth forecast for 2025 to 1.5% to 0.75%.
Inflation is expected to be higher than OBR. Back in October, the watchdog predicted inflation of 2.6% in 2025. The bank now expects a peak of 3.7% at the end of summer.
Business leaders warned that Reeves’ fall budget increased economic headwinds, believing that £25 billion from employers’ national insurance contributions would force them to lay off employees or raise prices.
However, Reeves told the Guardian last week that the fall budget will not turn around. “I will not regain the budget in any way. This budget allows us to start cutting the NHS waiting list, invest more money and restore economic stability.”
What can the Prime Minister do?
The Treasury Ministry said the fiscal rules were “unnegotiable”, which suggests that the OBR forecasts show that the violations will lead to the prime minister cutting spending or raising taxes to ensure they are still met. It will be tough as Reeves promises not to raise the Treasury’s three biggest income gains (income tax, VAT and state insurance) and to bear pressure to fund the revival of public services.
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Charlie Bean, a former OBR member and former bank deputy governor, said the prime minister would be better off either allowing the borrowing to rise – breaking fiscal rules or announcing a broad tax rise based on broad taxes.
“The bigger adult way to do it is to have the Prime Minister say, ‘Well, I’m now putting my rules over billions or anything, but we know the forecast is bouncing. I haven’t finished the spending comments yet and I’m going to get back to that in the fall,” he said.
“That is, just saying that this may not be cut off at the current moment, especially given that her personal credibility may have been somewhat weakened.”
Keir Starmer cuts international aid budget after Reeves warned of “hard decisions” to comply with fiscal rules.
To cope with the rising costs of debt services and the loss of economic sluggishness, Reeves said she will prioritize spending cuts and “eliminate waste.”
This could mean tighter restrictions on public spending in the later years of parliament, although details are still being provided for the expenditure review – which will be completed in June. Welfare cuts can also be announced, which frustrates charities and labor backseaters.
Reeves promised no more tax increases by the end of last year, aiming to ease business anger after the fall budget. But at this point, the power of her language has eased in recent weeks. The Financial Times also reported that Reeves opened the door to change, including the possible extension of the freezing of the income tax threshold beyond 2028.
Reeves said last week that when she announced a £40 billion tax increase, she promised “not to repeat what I have to do in October”, but did not rule out smaller income hikes.
“The Prime Minister will never exclude himself from the scope of the taxes again. I will not fall into that trap,” she said.
