Modest improvement in UK borrowing still leaves the Chancellor in a fiscal straightjacket

A better set of borrowing figures were posted by the UK this morning, showing borrowing has come in below forecast over the first third of the current financial year to boost hopes that the government will be able to offer some modest tax cuts to voters ahead of the next general election due by January 2025. Overall borrowing from April to July was £56.6bn, some £11.3bn less than forecast and, importantly from a government public relations perspective, means that the overall size of the fiscal deficit has not exceeded the size of the economy, a threshold that had previously been reported as having been crossed.

The tight labour market and the strong wages growth it is fuelling is proving to be one of the main driving forces behind the improved figures, boosting tax receipts and helping to offset the higher debt costs attributable to rising interest rates and high inflation, the latter also providing a windfall of higher VAT receipts. However, how much room the government will ultimately have to cut taxes next year remains uncertain and is likely to be very limited. Borrowing in July was still £1.1bn higher than July last year, highlighting that much work is still to be done to actually start bringing down the size of government borrowing rather than simply slowing its expansion. And with the BoE very much trying to engineer a loosening in the labour market as it struggles to bring CPI back to target, how long the government will be able to rely on excess employment taxes remains equally unclear. The government will also be wary of the recent downgrading of the US credit rating from AAA to AA by Fitch and will be keen to ensure that a similar fate is not suffered by the UK.

But as noted above, the key question for UK taxpayers will be how much room the Chancellor might have to ease the tax burden ahead of the next general election. Despite the modest improvement in the public finances seen today, our suggestion is it is still doubtful that there will be sufficient financial headroom for any meaningful tax cuts or spending increases to be made. In his most recent budget, the Chancellor suggested there was headroom of just £6.5bn available if the target of the debt/GDP ratio falling in five years’ time was to be met. Since then, debt servicing costs have risen in line with rising interest rates and yields, and the outlook for debt interest payments continues to deteriorate as yields move higher. Any recalculation the Office for Budget Responsibility made now of the Chancellor’s forecasts using current market interest rates would result in a substantial increase in projected debt interest obligations, estimated to be in the order of £40bn next fiscal year. This effectively rules out any relaxation in the fiscal stance.

In conclusion, therefore, today’s numbers will be welcomed by the government as evidence that the steps it is taking to get borrowing back under control are bearing fruit. But in reality the figures simply point to a slowdown in the pace of deterioration rather than any meaningful improvement; the government’s overall debt burden is continuing to rise. And worryingly for its chances of staying in power, the prospect of any tax give-away ahead of the general election is still very much a pipe dream.