Tax or cut? Rachel Reeves faces fiscal headache before OBR forecasts
Chancellor Rachel Reeves will come under pressure to cut spending or increase taxes when she receives the latest growth forecasts from the fiscal watchdog next month.
The Office for Budget Responsibility (OBR) will publish its latest assessment of the UK economy on 26 March, which will factor in higher borrowing costs and weaker-than-expected growth.
This forecast determines whether Reeves is on track to meet her fiscal rules.
Economists widely expect that the OBR will slash its projections, reflecting the sluggish performance of the economy since the Budget.
In October, the OBR predicted that the UK economy would grow 2.0 per cent this year, which is comfortably ahead of many other independent forecasters. The current consensus among City economists is for annual growth of 1.2 per cent.
Just this week, two prominent City forecasters have cut their projections for this year following the poor end to 2024.
In a note published on Monday, Pantheon Macroeconomics reduced their 2025 growth projections to 1.1 per cent, down from 1.3 per cent previously.
“Payroll-tax hikes from the Budget are driving growth and inflation in opposite directions to a greater extent than we expected,” Elliott Jordan-Doak, UK economist at the consultancy said.
Growth prospects
EY also slashed its 2025 growth projections to 1.0 per cent on Monday, down from the 1.5 per cent forecast back in October.
Julian Jessop, an independent economist, noted on X that the recent downgrades make the OBR look like an “even bigger outlier”.
But Ruth Gregory, deputy chief economist at Capital Economics, pointed out a short term growth downgrade could be offset by forecasts for stronger growth down the line.
“If GDP recovers by 2029-30, then it won’t reduce the chancellor’s headroom,” she said.
However, the government also faces much higher borrowing costs. Gilt yields have recovered from their dramatic spike in January, but they remain well above last October’s level.
Estimates from the Resolution Foundation, published last week, suggest that higher borrowing costs alone have added about £7bn to the Treasury’s bill, wiping out nearly all of the £9.9bn buffer Reeves left in October.
“The cost of government borrowing is significantly higher than it was last year while growth remains anaemic. It means Reeves faces having to either restrain spending or increase taxes, both of which are politically challenging,” Allan Monks, chief UK economist at JP Morgan said.
What could Reeves do?
Further tax increases might not come as a surprise to voters, according to a poll from Freshwater Strategy and City PM.
A majority of voters (53 per cent) expect income tax and corporation tax to increase during the Parliament, while half think employers’ national insurance will increase again.
Over four in ten (44 per cent) think valued added tax will increase as well, indicating the degree of public scepticism about the government’s manifesto pledge to not increase taxes on working people.
Reports suggest that Reeves is likely to opt for spending cuts to balance the books in March, but tax rises might be on the cards in the autumn.
One option reportedly under consideration is to extend the freeze on income tax thresholds.
Amid the negative economic headlines news, the Chancellor has embarked on a growth push early in 2025, with major announcements on Heathrow, the Oxford-Cambridge Arc and planning reform.
But these measures are unlikely to impact the OBR’s forecasts, even if they have broadly been welcomed by business groups and economists.
“We view them as ultimately positive for economic growth, but not within our forecast horizon and probably not within the horizon relevant for the OBR’s fiscal assessment in March,” analysts at Barclays said.
A Treasury spokesman said: “The Government is committed to sound public finances and economic stability which is why our fiscal rules are non-negotiable. We will not provide a running commentary as the independent OBR prepares its forecast due to be published on March 26.”