Rachel Reeves is considering imposing steeper cuts to public services to repair the government’s finances after a bruising 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 reduce departmental spending even more than planned, having ruled out increases to either borrowing or taxes. Any measures to avoid breaking her fiscal rules could be announced at an emergency statement in the spring.
The prospect of a fresh spending squeeze comes as Britain’s financial position is being rattled by a dramatic sell-off in the global market for government debt, fuelling a rise in the UK’s long-term borrowing costs to the highest level since 1998.
On another day of drama in the markets after a challenging start to the year for Labour, Darren Jones, the chief secretary to the Treasury, sought to soothe investor jitters by insisting the markets for UK government bonds, known as gilts, remained “orderly”, while confirming that the government would stick to its fiscal commitments.
“It is normal for the price of yields and gilts to vary when there are wider movements in global financial markets including in response to economic data,” he told MPs on Thursday.
The Conservatives accused the government of saddling the economy with higher taxes and borrowing, and joined forces with the Liberal Democrats to call on Reeves to cancel her planned trip to China, but the chancellor went ahead with her flight on Thursday.
Economists warned the rise in borrowing costs could sweep away a £10bn buffer that Reeves had kept in reserve at 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 the yield – in effect the interest rate – on gilts be sustained, it would tee up a potentially damning verdict from the government’s independent forecaster, the Office for Budget Responsibility (OBR), when it delivers its next outlook for the economy on 26 March.
Reeves had been planning to make a low-key statement alongside these spring forecasts. However, senior Labour sources signalled that an OBR downgrade showing a breach in the 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 a fresh round of tax increases, having raised 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 is planning 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 the bond markets, conditions appeared to stabilise on Thursday to hand some breathing space to the chancellor as she prepared to fly to China on a mission to forge closer economic ties with Beijing.
Having risen earlier in the day on Thursday to the highest point since the 2008 financial crisis, the yield on 10-year UK government bonds fell back 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, dropping by a cent before easing back to settle half a cent down at $1.23.
While some investors drew comparisons with the market chaos triggered by Liz Truss’s ill-fated mini-budget, others said the latest gyrations bore little relation to the febrile conditions in 2022, when some bond yields rose at the fastest daily rate in 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 disorderly increase in yields. That then caused damage elsewhere. This time around it hasn’t been that.”
Government borrowing costs have risen worldwide in recent weeks as investors weigh up the prospect of the incoming US president, Donald Trump, stoking inflationary pressures – with 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 governor for financial stability, said that while Threadneedle Street was closely monitoring conditions in markets, most of the changes were being driven by global factors. “So far the moves have been orderly, we’ll continue to watch this space. So far so good,” she said.
With the government under pressure on its economic management, some investors suggested the government was likely to be forced to either raise taxes or cut spending amid questions over Labour’s credibility in markets. “We ultimately expect to see a spring budget alongside the OBR forecasts, where she signals greater cuts to government spending,” said Matthew Amis of the fund manager Abrdn.
The prospect of further funding reductions for Britain’s stretched public services is causing alarm among Labour MPs and some economists.
One backbencher told the Guardian the fear among their colleagues about further cuts was “massive” and that confidence in Reeves was dropping fast. Another said the move would lead to “brutal” cuts for non-protected departments.
George Dibb, an associate director for economic policy at the Institute for Public Policy Research, said: “Making further cuts to public services or departmental budgets is not necessarily the ‘easy choice’, nor will it fix the underlying problem. There’s little fat to be cut after years of austerity, and imposing more cuts at this stage could be damaging, to people’s lives and also to the economy.”
Cara Pacitti, a senior economist at the Resolution Foundation thinktank, 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 which will have a genuine impact on concrete items of long-term spending.”
Downing Street officials said, however, that any new spending reductions would “never be at the levels you could describe as austerity”, which Reeves and the prime minister, Keir Starmer, ruled out.