MARKET NEWS

Rachel Reeves’s headroom to balance Britain’s public finances has been wiped out by higher borrowing costs and a humiliating climbdown on welfare reform.

Economists warned that the Chancellor would have to raise taxes by “at least” £20bn in the autumn Budget against a backdrop of weak growth and interest rates that are likely to stay higher for longer.

Borrowing costs on UK government debt have climbed sharply since the Spring Statement in March, with long-term gilt yields now at their highest rate since 1998.

The Chancellor has just a £9.9bn buffer on her main borrowing rule to ensure tax revenues cover day-to-day spending.

Andrew Goodwin, the chief UK economist at Oxford Economics, said roughly £6.5bn of her headroom had already been wiped out from the rise in borrowing costs and investors believing the Bank of England will not cut interest rates again from 4pc this year.

Separate analysis by Capital Economics showed £2.5bn of this had been wiped out over the past seven days alone amid a rise in longer-term yields.

Official data published on Wednesday are expected to show that inflation rose to 3.7pc in July – its highest rate since the start of 2024 and almost twice the Bank’s 2pc target. Policymakers are increasingly worried that rising food prices will fuel demands for higher pay.

Mr Goodwin said this presented a “challenging” backdrop for the Chancellor who less than a year ago announced record tax rises of £40bn.

Ms Reeves was also forced to backtrack on a series of reforms to disability and incapacity benefits in the spring as well as restoring winter fuel payments to most pensioners in an about-turn that will cost £5bn.

Mr Goodwin said: “Rising gilt yields and markets reacting to the Bank of England’s more hawkish commentary are making the fiscal arithmetic look increasingly challenging.

“If market pricing stays where it is today, it will knock about £6.5bn off the £9.9bn of headroom. When you factor in the U-turns on welfare reforms and winter fuel payments for some pensioners, all of the headroom disappears.”

It came as a British hedge fund warned that bond vigilantes were poised to ramp up the cost of government borrowing around the world over fears about the size of the US debt pile.

FTSE 250-listed Man Group, which manages $193bn (£143bn) of assets, said investors unhappy at Donald Trump’s tax-cutting plans would soon “come out in force and drive yields up”.

Since early August, the 10-year Treasury bond yield – a benchmark for the cost of government borrowing – has climbed from 4.19pc to 4.33pc.

Kristina Hooper, at Man Group, said: “At some point, I would expect bond vigilantes to come out in force and drive yields up sustainably, but we will have to wait and see when”.

Oxford Economics expects Britain’s fiscal watchdog to announce a downgrade in productivity alongside its latest assessment of the economy and public finances in the autumn, which Mr Goodwin said would reflect “a more realistic view of long-term growth prospects”.

Ms Reeves has ordered officials to prioritise productivity-enhancing reforms in the Budget amid fears that a significant downgrade to the country’s growth prospects will force her to backtrack on a manifesto pledge to shield working people from tax rises.

The Office for Budget Responsibility (OBR) has previously warned that nudging down Britain’s long-term growth prospects by just 0.1pc would blow a £7bn hole in the Chancellor’s fiscal plans.

Mr Goodwin warned: “We could easily be looking at the Government needing to tighten policy by at least £20-30bn, and possibly more, at the Budget.”

Alex Kerr, at Capital Economics, estimated that the Chancellor would have to raise between £17bn and £27bn at the Budget “most of which will probably be funded by tax rises”.

Others have warned of a black hole of up to £50bn in the public finances.

It came as separate data showed that the UK economy grew faster than thought following the end of lockdown.

However, in another blow to Britain’s statistics office, the Office for National Statistics (ONS) postponed its latest retail sales data which were due on Friday “to allow for further quality assurance”.