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The UK government is drawing up fresh growth initiatives in an effort to avoid “disastrous” tax increases after a punishing week in the markets that threatens to derail its policy agenda.
UK borrowing costs climbed close to a 16-year high on Friday, closing out the worst week in a year for the gilt market after a sell-off that has dragged down the pound and left the government scrambling to reassure investors over the state of the public finances.
When Rachel Reeves returns from a trip to China on Monday, the chancellor plans to set out a convincing “growth narrative”, including new economic policies, with a set-piece speech expected later this month, according to officials.
Officials said the government is determined to avoid further tax rises on top of the £40bn package it set out in October, with one saying “it would just be completely disastrous”.
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Instead, the government is looking for growth and to rein in public spending following a damaging surge in government borrowing costs.
Officials and ministers are braced for potential cuts to departmental spending plans in the forthcoming spending review which, according to people familiar with the process, will be held on June 11.
As part of its pro-growth agenda, Labour plans to change the “write-round” process by which different departments agree to collective policy-making.
“Departments will be asked if the policy will have a beneficial impact on growth and if the answer is yes then we’ll do it — as a broad principle,” said a Treasury official.
At the same time, departments will also be given a firm message during the spending review process that if they are pushing policies that are a “drag on growth” then these will have to be “revisited”.
But economists warned that the gilt market sell-off had exposed serious weaknesses in the party’s strategy for the economy and public finances, criticising the government for failing to build in a sufficient margin for adverse changes in its October Budget, and for being slow to detail growth initiatives.
“They now need to show they are serious about addressing the UK’s fiscal challenges in a higher rates world,” said Ben Nabarro, UK economist at Citigroup. “That means getting to grips with structurally weak growth. But they are also likely misguided if they think growth alone can bail them out of this fiscal hole. Some spending and tax adjustments are also needed.”
The Bank of England says the economy failed to grow in the final quarter of 2024, after weaker-than-expected GDP readings late last year. Business surveys have revealed a loss of confidence following tax increases in the October Budget.
The 10-year gilt yield ended the week at 4.85 per cent, up 0.25 percentage points from a week earlier, while sterling fell as low as $1.219, its weakest level against the dollar since November 2023. Shares on the domestically-focused FTSE 250 index fell 4 per cent this week, the biggest decline since June 2023.
Reeves’ October Budget, which included a sharp increase in borrowing, has fallen victim to a sharp sell-off in global bond markets because of renewed fears over inflation.
That has dragged government bond yields higher everywhere as investors bet that central banks will be slower to cut interest rates. This has mixed with investor concern over the UK economy to push the country’s 30-year borrowing costs to their highest this century.
“The more yields go up, the worse the fiscal situation becomes,” said Mark Dowding, chief investment officer for fixed income at RBC Bluebay Asset Management.
Strong US jobs numbers added to the pressure on the bond market on Friday, prompting traders to bet on an even slower pace of interest rate cuts from the Federal Reserve. The next key moment for gilts will be UK inflation figures next week.
An area where Reeves will emphasise major reforms is by setting out fresh details of a new “planning and infrastructure bill” which should be introduced in the House of Commons in March and aims to speed up development.
One senior Labour MP said: “The government desperately needs to bring forward a growth plan … and that’s more important than ever for businesses which are facing higher national insurance, a new package of employment rights and a higher minimum wage.”
Another Labour veteran said that the recent polling putting Labour as low as 24 per cent made him want to “bang my head against a table”, though they said Starmer’s leadership was probably safe for at least another year. “If Labour start to look as if they haven’t got a coherent or even plausible narrative to sell the markets then they are doomed, no?”
Data visualisation by Keith Fray