What surging cost of borrowing means for Rachel Reeves’s tax plans

A bit of a shocker has emerged on the public finances, and it is unambiguously bad news. Britain borrowed some £20.7bn last month – the second-highest June figure since records began in 1993 and behind only the panicky pandemic year of 2020.

It was £6.6bn higher than in June 2024, and as much as £16.4bn of the total was accounted for by debt interest. Worse than any of that, it was higher than City expectations. The gilt market was further discomfited. Pressure on the public finances is plainly not easing…

Inflation, is the short answer. It was up again last month and is likely to edge higher in the coming months, thanks to a bump up in energy costs. About a quarter of UK debt is index-linked to prices, which means that any uptick in official inflation feeds directly through to the public finances. And domestic pressures on public spending remain acute. Britain’s government pays more to borrow funds than most comparable advanced economies thanks to Brexit, Trump's trade wars, Covid recovery, and longer-term weakness in investment and productivity.

Keep her job is one thing. During the welfare bill rebellion fiasco earlier this month, the rumour that she might be sacked or quit pushed gilt yields higher, which in turn meant that raising new money would be even more costly. Yields subsided, but stability at the Treasury is a valuable asset in itself; markets fully expect another tough Budget, as does everyone. Given setbacks in social security spending and disappointing growth, she’ll probably need to raise another £20bn to be on the safe side, to deal with future shocks and meet her own “iron clad” fiscal rules.

Mainly new taxes, and that includes sin taxes such as on gambling, sugar in food, or petrol and diesel. She might also tighten up tax breaks on pension savings, extend the freeze on income tax thresholds, and target capital gains (again). She might also ask the Bank of England not to pay so much interest on the deposits commercial banks keep with it; that might sort most of it out, but she’ll still need to look again at aspects of public spending. There seems less hope that the two-child benefit cap will be lifted.

The person Rachel Reeves would have to negotiate with is Rachel Reeves, so it’s possible she could persuade herself to tweak the rules again; but as she pointed out at the recent Mansion House dinner, rules about borrowing merely reflect the reality of market sentiment. If the market can tolerate another adjustment, it might happen – but probably not at the moment.

Yes. The weight of expectations is too heavy and the Bank still judges that, a year to 18 months out, inflation will subside back toward the target rate of 2 per cent (absent any nasty surprises). So interest rates will be down to 4 per cent next month; after that, we may have a bit of a wait because service sector and wage inflation remain stubbornly elevated.

Labour desperately needs to win a reputation for economic competence, and the image of a government not in control of spending and debt would dump the party out of office for another generation. A Tory or Reform government on the back of chaos would be a nailed-on certainty for the next election, whenever it comes.

However, an immediate major crash, such as was seen after the 2022 Truss mini-Budget, the collapse of sterling out of the Exchange Rate Mechanism in 1992, or the 1976 IMF crisis, doesn’t seem likely. It’s more of a long, thankless and politically bruising slog for the next few years to get the public finances on a sustainable basis. Contrary to some predictions, Reeves may have to spend longer in her “dream job” than even she might wish for.