Prime Minister Andy Burnham and Chancellor John Healey face growing pressure to raise taxes if they want to deliver meaningful Burnham Healey cost of living support, after a surge in government borrowing costs tightened the squeeze on the public finances. Several economists warned that higher-than-expected borrowing in July, combined with rising gilt yields, has left little room to fund fresh spending packages without either resetting existing budgets or increasing the tax burden.
Gilt market pressure narrows the options
Ten-year gilt yields, the benchmark for government borrowing costs, hit a peak of over 5.1 per cent this week before dropping back slightly, as concern grew that the Iran war could drag on and disrupt trade across the Gulf region. The pressure is not confined to the short end of the curve. According to Ainvest, 30-year gilt yields have surged to 5.7 per cent, the highest level since 1998, a development that further complicates the government’s financing position.
The Bank of England has warned it could raise interest rates in response to continued trade disruption in the Gulf, a move aimed at easing inflationary pressures. That prospect adds to the £110bn debt interest load the government already carries.
Matt Swannell of the ITEM Club said that current market pricing on bonds would strip out roughly £7bn of the £23.6bn in fiscal headroom the government holds under its own fiscal rules. He stopped short of saying it would force additional tightening, but said it could ‘limit Chancellor Healey’s room for manoeuvre’.
Swannell said the government would likely continue its approach since Burnham became Prime Minister, focusing on lower-cost interventions. ‘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,’ he said. ‘Anything more fundamental than this would require other spending cuts or tax rises.’
Researchers at the Resolution Foundation said the effective fiscal headroom could be lower than £8bn altogether, given that the Iran war’s effects could still weigh on output growth.
Burnham Healey cost of living choices ahead of the Budget
Borrowing has risen more sharply than expected in recent months, in stark contrast to inflation and growth figures, which have come in more favourably than forecast. The divergence puts Healey in a difficult position ahead of the Budget. The government faces dual pressure: to lift defence spending towards three per cent of GDP and to support families hit hard by the cost of living.
Capital Economics suggested there would be ‘little scope’ to raise borrowing in the Budget. Ruth Gregory, deputy chief UK economist at the consultancy, said traders might prove ‘more tolerant’ of extra borrowing if it was directed at investment and structured cost-effectively, but cautioned that any interference with the current fiscal rules could revive ‘sensitivity’ in the markets. A maximum of about £15bn in additional borrowing could be accepted, according to Capital Economics, though the consultancy said tax rises were likely.
Ashley Webb, a senior economist at Capital Economics, warned separately that the UK was on track to post a deficit of above four per cent of GDP for the seventh year in a row. He attributed weak recent borrowing data in part to higher welfare payments running about £2bn above levels seen the previous year.
The scale of the government’s financing task is underlined by data on gilt issuance. Room151 reports that the Debt Management Office has unveiled plans for £299.2bn of gilt sales in 2025 to 2026, with short-dated securities accounting for 37 per cent of the total at £110.9bn, the largest allocation to short-dated maturities since 1998. That volume of issuance, at a time of elevated yields, will itself feed back into borrowing costs.
For context, MoneyWeek reported that 10-year gilt yields had fallen to 4.37 per cent in January, illustrating how quickly conditions can shift. The subsequent climb past 5.1 per cent represents a material change in the cost of servicing new debt.
Reuters has reported separate budget watchdog estimates that put fiscal headroom at close to £22bn over a five-year horizon, though economists cautioned that ongoing market volatility and the Iran conflict’s unpredictable effects on growth could erode that figure well before the Budget lands.
