Chancellor Rachel Reeves could have to rein-in public spending further or introduce new tax increases if current pressures facing the nation's finances cannot be offset, independent think tank the Institute for Fiscal Studies has warned.
The civil service's biggest union, PCS, vowed to fight Reeves "every step of the way" if the chancellor sought to sacrifice public sector jobs and spending on services to meet her fiscal rules.
But an unnamed HM Treasury source quoted in the Guardian today suggested cuts would be the government's preferred choice. "If we have to choose between raising taxes and cutting spending, we will cut spending," they said.
Reeves' October Budget set broad-brush spending plans for the coming years, with notional increases for all departments. However, the front-loaded nature of the rises has resource spending set to increase by just 1.3% in the final three years of the five-year period, implying real-terms cuts for so-called "unprotected" departments.
The Treasury is currently working on the government's multi-year spending review covering 2026-27 to 2028-29, which will confirm allocations for departments. It is currently expected to be delivered in June. When the process was launched, permanent secretaries were put on notice that the chancellor is expecting 5% efficiencies from them across the period. A worsened long-term financial outlook could well force the Treasury to seek further belt-tightening.
IFS deputy director Carl Emmerson and senior research economist Isabel Stockton said yesterday that changes to the government's borrowing costs could wipe out Reeves' ability to meet her fiscal rules and deliver a balanced budget in 2028-29.
"At the October Budget, the OBR was forecasting a current budget surplus of 0.3% of national income (around £10bn) in the three later years of the forecast," they wrote in a comment piece.
"This is a razor-thin margin and even small forecast changes might mean that further tax rises or a trimming back of planned spending would be necessary to continue to meet the target.
"An increase of half a percentage point across relevant interest rates – similar to the increase seen over the last month in 10-year gilts – would, if sustained, be expected to add some 0.25% of national income to debt interest spending in four years’ time. This is around £8bn."
Emmerson and Stockton said that unless the Office for Budget Responsibility was to revise up growth or inflation at the same time, increased borrowing costs would reduce the margin against the fiscal target to "almost nothing".
They added: "The issue here is not that the past month has been especially economically or fiscally eventful, but that the margin was so small to begin with."
The OBR is due to deliver its next outlook for the economy on 26 March. The Guardian said Labour Party sources had "signalled" that a downgrade from the watchdog would require action from Reeves.
Fran Heathcote, general-secretary of PCS, said the public sector was in no mood for a new wave of austerity, delivered by a Labour government rather than the Conservatives. She said ministers should instead seek to raise the funding required to deliver services.
"If the chancellor comes for our members’ jobs, and the services they provide, we’ll fight her every step of the way," Heathcote said.
"She will be committing an unforgivable mistake by forcing civil servants to pay for a financial situation not of their making.
"Fourteen years of austerity tells us you can’t cut your way to growth. The government should be taxing those who can afford it, not taking away pay from those who cannot."
Reeves is due to arrive in China as part of a trade-boosting delegation. She faced criticism from shadow chancellor Mel Stride and Lib Dem leader Sir Ed Davey for proceeding with the trip.
Culture secretary Lisa Nandy defended Reeves' decision go ahead with the trip as "right and proper".
Nandy told BBC Radio 4's Today programme that fluctuations affecting the bond market and sterling were part of "a global trend" that was affecting economies all over the world.