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Prime Minister Sir Keir Starmer repeatedly warned of difficult decisions leading up to Wednesday’s Budget. His chancellor certainly followed through.
Rachel Reeves unveiled the UK’s largest tax-raising package since the early 1990s, imposing a £25 billion annual national insurance hike on employers along with increased capital gains tax and a crackdown on non-doms, all to finance a £70 billion annual boost in public spending.
However, projections from the Office for Budget Responsibility, the UK’s fiscal watchdog, indicated that more than just this single Budget would be needed to achieve her main objectives — to effectively restore public finances and end the UK’s slow-growth problem.
The OBR forecasts suggest that significant increases in public spending will generate an initial surge in growth, but will have little impact on GDP over the next five years, resulting in the state playing a larger role in the economy at the expense of consumers and businesses.
While the chancellor will meet her newly established fiscal rules, she has eased fiscal policy compared to the previous position in March. Borrowing is expected to average £28 billion over the next five years, with the government spending over £100 billion on debt interest annually.
“That cost doesn’t just disappear because you’re targeting a different measure,” noted Richard Hughes, chair of the OBR, highlighting that rising debt servicing costs are “one reason the tax burden is so much higher”.
Some additional borrowing was anticipated — Reeves has made it clear that she is shifting her fiscal approach to enable tens of billions of pounds in additional investment.
However, the OBR’s conclusion is that the Budget represents one of the largest fiscal relaxations in recent decades, with overall borrowing expected to be £142 billion higher than previously projected between 2024-25 and 2028-29.
The combination of new taxes and borrowing will allow Reeves to increase spending by around £70 billion annually over the next five years, pushing the size of the state to 44 percent of GDP.
Approximately one-third of this increase will be allocated to capital spending, with the rest going towards day-to-day spending on public services — with a significant portion directed to the NHS and schools.
Paul Johnson, head of the Institute for Fiscal Studies, cautioned that the spending increases are heavily front-loaded, with day-to-day spending set to rise by 3.1 percent in 2025-26 before sharply decreasing to 1.3 percent annually in real terms thereafter.
He expressed skepticism about promised future cuts: “A government splurging in the short term and pledging to be more frugal in the future? Stop me if you think you’ve heard this one before.”
Areas of public services may still face pockets of austerity, potentially necessitating additional rounds of tax hikes. Hughes observed that outside protected sectors like health, defense, and overseas aid, spending on all other departments is projected to decline by 1.1 percent annually in the final four years of the forecast.
Meanwhile, the economic growth revival that Reeves is aiming for could take a long time to materialize. The OBR stated that the net impact of all measures announced in the Budget would only be positive from 2032-33 onwards — implying that Labour would need to win the next election to benefit from the effects.
The boost in capital spending could increase potential output by 1.4 percent if sustained over 50 years.
In the short term, the fiscal relaxation is likely to fuel inflation and crowd out private sector investment, the OBR warned, suggesting that it could prompt the Bank of England to set interest rates about 0.25 percentage points higher than originally anticipated.
David Miles, an OBR official, described this impact as “neither completely insignificant nor a game-changer”. However, consumers may face a triple whammy of higher prices, increased borrowing costs, and lower wages compared to previous expectations — even as Reeves maintains stringent welfare policies.
The OBR anticipated that CPI inflation would rise to 2.6 percent next year, up from a prior projection of 1.5 percent, before moderating as the BoE takes action.
Despite Reeves’ pledge to put “more pounds in people’s pockets,” the eventual increase in employer taxes is expected to be borne by workers — who may see slower wage growth over time.
Partly due to this, the OBR foresees household disposable income being approximately 1 percent lower after five years than initially expected in March, with household consumption representing a smaller share of GDP — although, as Miles pointed out, improved public services could support living standards.
In swap markets, investors adjusted their expectations to anticipate three or four quarter-point rate hikes by the BoE over the next 12 months, rather than four or five.
According to some economists, Reeves has struck a balance. Michael Saunders of Oxford Economics remarked that the overall fiscal consolidation path is now based on a more credible foundation of specific tax increases, rather than an unrealistic and unspecified squeeze on public spending.
While the overall budget deficit may be decreasing at a slower pace, it is projected to shrink from 4.5 percent of GDP this year to about 2 percent of GDP in 2029-30.
The new current Budget rule, requiring day-to-day spending to be covered by taxes, is expected to be met with a narrow margin of £9.9 billion in 2029-30, as per the latest forecast.
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As anticipated, the chancellor has adjusted her debt target to support investment, shifting the focus to “public sector net financial liabilities”. This target is projected to be met with a margin of £15.7 billion.
However, the UK’s fiscal situation remains challenging. Ongoing pressures on public services could mean that Reeves may need to announce further tax increases in the future.
“She may very well have to return with another round of tax hikes in a couple of years,” Johnson remarked, “unless she is fortunate with economic growth”.
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