Reeves's biggest Budget headache is not Starmer's welfare reversal

Telegraph

22-07-2025

Embarrassing about-turns on welfare and winter fuel payments may be fuelling speculation of an autumn tax raid. But public borrowing data on Tuesday show that policy changes are far from Rachel Reeves's biggest problem.
The cost of servicing Britain's £2.7tn debt pile almost doubled in June compared with a year ago to £16.4bn as higher-than-expected inflation pushed up debt costs.
The Office for National Statistics (ONS) said this was the second-highest interest bill since monthly records began in 1997, eclipsed only by June 2022 just after Vladimir Putin invaded Ukraine.
It meant the Government had to borrow £20.7bn in June to plug the gap between tax receipts and revenues. That is much higher than a year ago and £3.5bn more than forecast by Britain's tax and spending watchdog in the spring statement.
In fact, outside the height of the pandemic in June 2020, it represents the highest borrowing total for that month since records began in 1993.
The £16bn debt interest bill in just one month dwarfs the cost of Labour's decision to shelve most of its welfare reforms and hand back winter fuel payments to most pensioners, which cost a combined £5bn a year.
Debt interest costs as a share of tax revenues have risen faster than any other G7 nation, even though the US is now quickly catching up amid Donald Trump's trade war.
Costs are forecast to stay high too, with the Office for Budget Responsibility (OBR) predicting an annual bill of £130bn by the end of the decade. That's double the entire defence budget and higher than spending on any government department outside health.
The Chancellor's decision to fiddle her fiscal rules masks the fact that debt will continue to march towards 100pc of GDP every single year this parliament.
Richard Hughes, the chairman of the OBR, recently pointed out that the UK Government had the sixth-highest debt, fifth-highest deficit and third-highest borrowing costs among 36 advanced economies at the end of last year.
As a result, rising gilt yields and a wafer-thin margin of £9.9bn to balance the books means even small increases in Britain's borrowing costs have become enough to blow Reeves off course.
Unfortunately for the Chancellor, Nabil Taleb at PwC believes the UK faces another upward lurch in borrowing costs that will be largely out of her control.
'With global uncertainty persisting, particularly around the impact of US policy, the cost of servicing UK debt could climb even higher,' he says.
It's a view echoed by Schroders, which recently warned that 'US influence over the global economy and financial system' could 'cause debt dynamics to worsen' around the world as Trump continues to wage his trade war.
Gilt yields have climbed since the spring statement in March, particularly when it comes to longer-term borrowing.
The recent welfare rethink also created ripples in the bond market, arguably a more significant impact of the policy about-turn than the cost of the change itself.
Even the Chancellor's tears were enough to send Britain's borrowing costs higher.
Analysis by Capital Economics shows the rise in UK gilt yields since March has already eroded her headroom from £9.9bn to £6.7bn. Pile that on top of the about-turns, and she's already got a £10bn hole to fill if she wants to maintain that borrowing buffer.
Slow growth threat
Debt may be one of the biggest problems facing Reeves, but it is far from the only one.
A cut to Britain's growth forecast could blow a similar hole in the public finances.
Higher interest rates and borrowing costs also mean the Treasury will be forced to fork out more money to subsidise the Bank of England's bond sell-off.
After years of buying, the Bank of England is unwinding this stockpile at a considerable cost because bond prices are much lower and interest costs much higher than a few years ago. This means the Bank is making far less from its bond purchases than it has to fork out in interest payments on reserves parked at Threadneedle Street. The Treasury has agreed to cover the difference.
The Bank is also actively selling its stockpile of gilts back to the market in a move called quantitative tightening (QT), crystallising billions of pounds of losses for the taxpayer.
The ONS said the Treasury had transferred £4.1bn to the Bank so far this year to ensure the Old Lady didn't suffer any losses. This is expected to rise much further as the year goes on.
Alex Kerr at Capital Economics says the recent about-turns on spending cuts and potential upward revisions to the OBR's borrowing forecasts 'means the Chancellor will probably need to raise between £15bn and £25bn at the autumn Budget to maintain the £9.9bn of headroom against her fiscal mandate'.
He adds: 'Given that she is struggling to stick to existing spending plans and we doubt the gilt market will tolerate significant increases in borrowing, she will probably have to raise taxes instead.'