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The British government finds itself in a difficult situation. As the cost of its borrowing has increased since the fall, the chances of sticking to its main self-imposed fiscal rule – borrowing only to invest by the end of the decade – have diminished. This setback was met with fierce rhetoric from the government. Whether from Prime Minister Sir Keir Starmer, Rachel Reeves, his Chancellor or their spokespeople, the adjectives to describe the fiscal rules have tended to oscillate between “battleship” And “non-negotiable“. Their attitude is always “absolutely committed“.
Confidence has improved in UK government bond markets over the past week, but many are still not convinced. Ray Dalio, the billionaire founder of hedge fund firm Bridgewater Associates, is far from impressed, saying gilts could be headed for a “death spiral“. Of course it was exaggerated, but his comments reflect a wider concern in financial markets that there is a gap between tough fiscal rhetoric and the reality of UK fiscal policy – and this long predates the Labor government current.
What is needed to provide fiscal stability on which the rest of the UK economy can rely is therefore simple. No more rhetoric. No more announcements of tightening fiscal policy, neither now nor in the future. Instead, Reeves must implement the tax increases and spending plans introduced in October without any compromise on when they are to take effect in April.
These are important. Alongside the large and disorderly increase in employers’ national insurance have been continued increases in income tax in the form of benefit freezes and less than lavish increases in public spending. Together, the measures are set to reduce significant public borrowing. The overall deficit is expected to fall from 4.5 percent of GDP in 2024-25 to 3.6 percent in 2025-26, while the current fiscal deficit, excluding capital investment, is expected to halve from 2 percent of GDP at 0.9 percent. over the same period.
This will be a demonstration exercise, not a story. Cutting borrowing on such a scale is quite rare for UK governments – it will become clear by the summer whether Reeves and his policies are on the right track. Success would immediately demonstrate a difference between the UK’s fiscal policy and that of similar countries.
In recent years, US administrations have shown no capacity to run a deficit well below 6 percent of GDP, and there is no improvement in sight. European Commission expects French budget deficit to fall exceeded 6 percent of GDP last year, with little chance of reaching a political agreement that would bring big improvements. Germany’s underlying public finances are strong, but its economy is weak. And the UK’s debt levels, while high, remain much lower than Italy’s.
Bond markets often have their own will, but it would be difficult to impose any particular sanction on the UK if it is the only advanced country of decent size with the capacity to pass legislation to force fiscal consolidation and to carry it out successfully. This is what Reeves needs to do. If growth suffers, the Bank of England would be in a strong position to ease monetary policy and offset fiscal tightening.
There are no guarantees when it comes to persuading financial markets that they have more to lose if they bet against you. The UK government must also hope that consumers will start spending their recent real income gains and improve growth. It must demonstrate that any expansion will be accompanied by some recovery in productivity growth. And that increases in employers’ social insurance should not have a much more damaging impact on employment and prices than expected.
No result will be achieved with more talk of non-negotiable commitments to ironclad fiscal rules.