Andy Burnham will struggle to deliver “fundamental” cost of living support without raising taxes, economists have warned, following a sharp spike in government bond yields.
Higher than expected government borrowing in July has deepened problems for the UK’s public finances, narrowing the range of extra cost of living measures available to the Prime Minister.
Higher gilt yields and pressure on the state to soften the impact of the energy price shock mean Burnham and Chancellor John Healey may not be able to announce fresh spending packages without resetting existing budgets or raising taxes.
Gilt yields over a 10-year horizon, the benchmark for government borrowing costs, hit a peak of over 5.1 per cent on Tuesday before dropping back slightly amid concerns the Iran war could drag on.
The Bank of England has warned it could hike interest rates as a result of continued trade disruption across the Gulf region, which could add to the £110bn debt interest load currently faced by the government.
ITEM Club’s Matt Swannell said that current market pricing on bonds would remove about £7bn of the £23.6bn fiscal headroom available under the existing fiscal rules.
While he said it would not “force additional fiscal tightening”, it could “limit Chancellor Healey’s room for manoeuvre”.
“We think that the government will likely continue to follow its playbook since Andy Burnham became Prime Minister, with a focus on low-cost measures to address the cost of living, such as the announced cap on bus fares and upcoming suspension of VAT on electricity bills,” Swannell said.
“Anything more fundamental than this would require other spending cuts or tax rises,” he added, underlining the constraints bearing down on the government’s domestic agenda.
Researchers at the Resolution Foundation said the size of fiscal headroom was likely to be even lower than £8bn altogether as the Iran war’s effects could still hit output growth.
Borrowing has risen more sharply than expected in recent months, in sharp contrast to inflation and growth statistics, which have come in more favourably than forecasts.
The situation puts Healey in a difficult position ahead of the Budget, with the government under pressure to raise defence spending to three per cent of GDP while also supporting families struggling with rising costs.
Capital Economics analysis suggested there would be “little scope” to raise borrowing in the Budget later this year, with a maximum of about £15bn considered acceptable by the consultancy.
Deputy chief UK economist Ruth Gregory noted that traders may be “more tolerant” if extra borrowing was used for investment and if it was cost-effective, though interference with current fiscal rules could bring back “sensitivity” in the markets.
A separate note by senior economist Ashley Webb warned that the UK was on track to post a deficit of above four per cent of GDP for the seventh year in a row.
Webb also warned that weak performance in recent borrowing data was due to higher welfare payments running about £2bn above levels recorded last year.