(Bloomberg) -- Prime Minister Keir Starmer is facing more difficult decisions on tax and spending after UK government borrowing came in higher than forecast in the first four months of the fiscal year.
The budget deficit totaled £51.4 billion ($66.9 billion) between April and July — £4.7 billion more than the Office for Budget Responsibility expected in March. July alone saw the Treasury in deficit by a larger-than-forecast £3.1 billion, while the national debt remained at levels last seen in the early 1960s at 99.4% of GDP.
The figures provide a snapshot of the public finances as Labour came to power in a landslide election victory on July 4 that ended 14 years of Conservative Party rule. The latest data suggest the sharp pickup in the economy this year is doing little to help, adding pressure on Starmer and Chancellor Rachel Reeves to raise taxes or curb spending to meet their fiscal rules.
“Today’s figures are yet more proof of the dire inheritance left to us by the previous government,” said Chief Secretary to the Treasury Darren Jones. In a spending audit last month, Reeves identified a separate £16.4 billion fiscal hole bequeathed by the Conservatives, which would come on top of the current shortfall.
Isabel Stockton, senior research economist at the Institute for Fiscal Studies, said: “Early signs are that better-than-expected growth figures won’t be enough save Rachel Reeves from tough choices in her first budget. The combination of in-year spending pressures identified at last month’s spending audit and the ongoing, and well known, pressures facing many public services suggest that the accompanying spending review for 2025-26 could be a particularly difficult exercise.”
Reeves has warned of “difficult” decisions in her first budget on Oct. 30. She has already scrapped winter fuel payments for 10 million pensioners, and hinted at tax rises and further cuts to benefits.
The borrowing overshoot so far this year has been almost entirely down to higher spending. Receipts in the year to date were £800 million lower than the OBR forecast but spending was £9.2 billion higher, driven by big increases staff and departmental running costs as well as welfare benefits.
The ONS clarified that the £10 billion in additional pay settlements for public-sector workers agreed by Labour to settle strikes has yet to appear in the fiscal numbers. Starmer has signed off on pay rises of 22% over two years for junior doctors and a 5% backdated increase for some train drivers.
Borrowing for the first three months to June was revised down by £1.5 billion but a big increase in spending in July dragged the overall budget shortfall deeper into the red against the OBR projections.
July is usually one of the better months of the year for the public finances, as the Treasury receives installments of self-assessed income tax and revenue from corporate profits. But the £3.1 billion budget shortfall was the largest for the month in three years. The OBR had expected the budget to be in balance, while economists predicted a deficit of £1.5 billion.
Rob Wood, chief UK economist at Pantheon Macroeconomics, said: “Chancellor Rachel Reeves will likely have to raise taxes and borrow more in the medium term to cover spending on public services.”
He estimated that Labour may have to borrow around £20 billion a year more than planned in the March Budget. Alex Kerr from Capital Economics expects Reeves “to raise an additional £10 billion a year via higher taxes and increase borrowing by around £7 billion a year.”
The Treasury also transferred another £12.2 billion to the Bank of England in July to cover losses on its quantitative easing portfolio of government bonds. It was the second-biggest quarterly transfer since they began in October 2022 and takes the total to £73.1 billion. Between 2009 and 2022, the portfolio made £124 billion in profits, which means the net gain is now just £51 billion.
Reeves could reduce the cost of the QE portfolio by paying less or no interest on some of the reserves that back the gilts. If the BOE ended active gilt sales, letting them passively mature instead, it would save around £10 billion a year.
She has also not ruled out changing the debt measure used in the fiscal rules, which could increase her borrowing headroom by as much as £16 billion.
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