When Harold Macmillan, Britain’s prime minister from 1957 to 1963, was asked what he saw as the greatest challenge for a politician, he reputedly replied, “Events, dear boy, events”.
Those words might have occurred to Britain’s Chancellor of the Exchequer, Rachel Reeves, as she delivered her spring fiscal statement last week.
The events of the last five months, since the October budget, have not been kind to the chancellor, or to the economy. GDP growth this year is now forecast to be just 1.0%, half the Office of Budget Responsibilities’ (OBR’s) October forecast, while borrowing costs are significantly higher.
In the absence of changes to policy, a deteriorating economic environment – and its impact on public borrowing, receipts and spending – would have put the chancellor on course to break what she has called “non-negotiable” rules for limiting public debt. Instead, through a combination of cuts to sickness and disability benefits, reductions in government spending elsewhere and improvements in tax compliance, the chancellor has been able to restore the degree of fiscal headroom for meeting her targets to exactly the level, £9.9 billion, that she had pencilled in last October.
Back in October, headroom of £9.9bn looked extraordinary narrow and liable to be demolished by adverse shocks. In an economy where GDP runs at £3tn, with government spending around £1.35tn, a cushion of £9.9bn is hardly even a rounding error.
For the chancellor to meet her fiscal targets, growth needs to come in line with the OBR’s optimistic growth forecasts for the next four years. That, in turn, requires a marked improvement in productivity growth. Government borrowing costs also need to stay around current levels. A significant external shock would knock everything off course. The OBR, for instance, estimates that a global tariff war – one where countries effected by a 20% US tariff responded in kind – could reduce UK GDP by 1.0%.
The UK is in an era of big government. Public expenditure is set to run at around 45% of GDP through this parliament, four percentage points higher than before the pandemic, and a level that has only been seen briefly, during recessions, since 1948. To finance this level of spending taxes are set to rise to 37.5% of GDP, the highest level since the late 1940s.
Increased public spending will help, as is already being seen with the recent decline in hospital waiting lists. However, many areas of public services will remain under pressure, especially in so-called “unprotected” departments such as justice, the Home Office and transport. Spending on these departments has been cut significantly in recent years and, according to the Resolution Foundation, they face further cuts averaging 4.5% in real spending per capita over the last four years of this Parliament.
The chancellor’s plan for relatively modest savings of about £5bn on the welfare budget – which slow, but do not reverse, the rise in the cost of sickness and disability benefits – will, on the government’s own figures, result in 3.2m families losing an average of over £1,700 and quarter of a million more people falling into poverty.
Local government faces particular challenges. Since 2020, eight councils have issued section 114 notices, the local council equivalent of declaring bankruptcy. Public satisfaction with council services is at the lowest level since polling started in 2010. Yet the Resolution Foundation finds that resources allocated from central to local government will continue to decline.
A more threatening global backdrop means that defence spending, which for years was shrinking, is on a rising path. Earlier this month the Financial Times’ Janan Ganesh wrote that Europe needed to “trim its welfare state to build a warfare state.”
Last November, Reeves said that the October budget, with its sizeable increases in taxation, borrowing and spending, had “wiped the slate clean” for the public finances. The reality is that the OBR assigns a probability of just over 50% to the chancellor meeting her fiscal rules. That almost guarantees continued speculation about the risk of future tax rises, spending cuts and changes to the fiscal rules to allow more borrowing.
The next major fiscal event will be in June, with the publication of the comprehensive spending review which will detail the allocation of funds between departments for the three years from 2026-27. This will be followed in the autumn with the budget, a crucial moment for assessing whether the Reeves strategy is on track.
The UK corporate sector has responded to the uncertainties of recent years by strengthening its collective balance sheet, paying down debts and building up cash levels. In many respects, the UK government has had to go in the opposite direction, raising borrowing and taxation, and running the public finances with a slim margin for error. Without consistent growth the public sector, and the public finances, will continue to struggle.
A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.
To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.