Reeves mulls deeper cuts to public services as borrowing costs rise | Economy

Rachel Reeves is considering introducing steeper cuts to public services to repair the government’s finances after a tough week in which investors drove up the cost of UK borrowing and pushed the pound to a 14-month low.

Government officials have told the Guardian the chancellor is prepared to cut departmental spending even further than planned, having ruled out increases to either borrowing or taxes. Any measures to avoid breaking her fiscal rules could be announced in an emergency this spring.

The prospect of fresh spending pressures comes as Britain’s financial position is rattled by a dramatic sell-off in the global sovereign debt market, pushing Britain’s long-term borrowing costs to their highest level since 1998.

In another day of drama in the markets after a challenging start to the year for Labour, Darren Jones, the chief secretary to the Chancellor of the Exchequer, sought to calm investor jitters by insisting that markets for UK government bonds, known as gilts, remained “orderly”, while that it confirms that the government would keep its fiscal commitments.

“It is normal for the price of returns and gilts to vary when there are broader movements in global financial markets, including in response to economic data,” he told MPs on Thursday.

The Conservatives accused the government of burdening the economy with higher taxes and borrowing, and joined the Liberal Democrats in urging Reeves to cancel her planned trip to China, but the chancellor boarded her flight on Thursday.

Economists warned that the rise in borrowing costs could sweep away a £10 billion buffer that Reeves had held in reserve in the autumn budget to meet her primary fiscal rule, which requires day-to-day spending to be matched by tax receipts.

Should the rise in interest rates – effectively interest rates – on the gilt stick, it would prompt a potentially damning judgment from the government’s independent forecasters, the Office for Budget Responsibility (OBR), when it delivers its next outlook for the economy on 26 March.

Reeves had planned to make a low-key statement along with these spring forecasts. However, senior Labor sources signaled that an OBR downgrade showing a breach of fiscal rules would not be allowed to pass without action to remedy it.

Jones repeatedly called the rules “non-negotiable” on Thursday, while a senior Downing Street official described them as a “red line” the government would not be willing to cross.

Treasury sources also say the chancellor is not planning another round of tax increases, after raising them by £40bn. in last year’s budget. “If we have to choose between raising taxes and cutting spending, we will cut spending,” said one.

Reeves has given most departments more money for the next two years, but plans cuts to unprotected departments of more than 1% a year after that.

Jones is now negotiating exactly how much money each department will get before the spending review is announced in June. But sources say Reeves could be forced to announce even deeper cuts before then.

After days of heavy selling pressure in bond markets, conditions appeared to stabilize on Thursday to give the chancellor a breather as she prepared to fly to China on a mission to forge closer economic ties with Beijing.

After rising earlier in the day on Thursday to the highest point since the 2008 financial crisis, the yield on 10-year UK government bonds fell from a peak of more than 4.9% to trade closer to 4.8%.

The pound fell to a 14-month low against the dollar at one point, falling a cent before falling back to settle half a cent down to $1.23.

While some investors compared it to the market chaos sparked by Liz Truss’s ill-fated mini-budget, others said the latest gyrations bore little relation to the frenetic conditions in 2022, with some bond yields rising at their fastest daily rates for more than two decades. .

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“This is not a Liz Truss moment,” said Mohamed El-Erian, the former deputy director of the International Monetary Fund who is now president of Queens’ College Cambridge. “The Liz Truss moment was defined by a very erratic rise in yields. It then caused damage elsewhere. That has not been the case this time.”

Government borrowing costs have risen globally in recent weeks as investors weigh the prospect that US President-elect Donald Trump will stoke inflationary pressures – with the potential to force the world’s most powerful central banks to hold back on cutting interest rates.

Sarah Breeden, the Bank of England’s deputy director of financial stability, said that while Threadneedle Street closely monitored market conditions, most of the changes were driven by global factors. “So far the movements have been orderly, we will continue to monitor this area. So far so good,” she said.

With the government under pressure over its economic management, some investors suggested the government was likely to be forced to either raise taxes or cut spending due to questions about Labour’s credibility in the markets. “We ultimately expect to see a Spring Budget alongside the OBR forecasts where she signals bigger cuts to government spending,” said Matthew Amis of fund manager Abrdn.

The prospect of further funding cuts to Britain’s sprawling public services is raising alarm among Labor MPs and some economists.

One backer told the Guardian that fears among colleagues of further cuts were “massive” and that confidence in Reeves was rapidly declining. Another said the move would lead to “brutal” cuts for non-protected wards.

George Dibb, associate director of economic policy at the Institute for Public Policy Research, said: “Making further cuts to public services or department budgets is not necessarily the ‘easy choice’, nor will it solve the underlying problem. There is little fat to cut after years of austerity and to impose more cuts at this time could be harmful to people’s lives and also to the economy.”

Cara Pacitti, senior economist at the Resolution Foundation think tank, said: “Announcing further departmental cuts would be suboptimal. Reeves should not allow short-term volatility in the markets to force her into really significant spending cuts that will have a real impact on concrete long-term spending.”

However, Downing Street officials said any new spending cuts would “never be at the levels you could describe as austerity”, which Reeves and the prime minister, Keir Starmer, ruled out.