Rising borrowing costs batter UK government and threaten left-leaning agenda
Six months into its tenure, Britain’s new labour government faces mounting challenges, with rising borrowing costs threatening to derail its ambitious left-leaning programme. Prime Minister Keir Starmer, who led Labour to a landslide victory in July, is under increasing pressure as higher taxes, unpopular spending decisions, and political controversies pile up.
The yield on 10-year UK government bonds, a key measure of the cost of borrowing, has risen by over 1.1 percentage points since mid-September. This surge has pushed borrowing costs to levels not seen since the 2008 financial crisis. Analysts point to sluggish economic growth and persistently high inflation as primary drivers of this trend.
The consequences are dire. As borrowing costs escalate, the government faces shrinking budgets for vital services, including the National Health Service (NHS), the military, emergency services, and education. While a slight dip in inflation in December offered brief respite, the road ahead remains fraught. If the economic outlook does not improve swiftly, the government may be forced to reconsider its pledges, including avoiding tax increases for “working people” and increasing public spending.
Global and domestic challenges
The rise in borrowing costs isn’t solely a domestic issue. Globally, bond markets are reeling from concerns about economic policies, notably those of US President-elect Donald Trump. Trump’s pledge to impose higher tariffs on imports has sent ripples through the global economy, leading to fears of higher consumer prices and prolonged interest rate hikes by the US Federal Reserve.
Domestically, the Labour government’s economic plan, spearheaded by Treasury chief Rachel Reeves, has come under scrutiny. Reeves based her strategy on the assumption that economic growth would bolster tax revenues, but stagnant growth has dashed these hopes. The UK economy has flatlined in recent months, with GDP showing no growth in the third quarter after modest expansions earlier in the year.
“The rise in gilt yields since the early autumn appears to largely stem from global factors rather than recent UK government decisions,” noted the Institute for Fiscal Studies (IFS). However, the UK’s precarious economic position amplifies these global pressures.
Stagflation and investor concerns
Britain finds itself particularly vulnerable due to its sluggish economy and high levels of public debt. Inflation, while slightly reduced to 2.5% in December, remains above the Bank of England’s 2% target. Meanwhile, government debt has soared to over 98% of GDP, the highest level since 1963.
Stagflation fears – a combination of stagnant growth and high inflation – loom large. “The UK is now in the eye of the storm,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown. “Concerns about a stagnating economy and inflation missing the Bank of England’s target are making investors wary of holding UK government debt.”
Adding to investor anxiety are Labour’s fiscal rules, which prohibit borrowing for day-to-day spending by 2030. Meeting these commitments is becoming increasingly challenging as borrowing costs climb. Despite the pressures, Reeves remains committed to avoiding tax hikes for ordinary workers, a cornerstone of Labour’s election campaign.
Searching for solutions
In response to these mounting challenges, the government has taken bold steps, including reaching out to China for trade and investment opportunities. Reeves recently travelled to Beijing on a three-day visit, a move criticised by some who view closer ties with China as a national security risk. However, Reeves defended the trip, arguing that engaging with China was essential for boosting economic growth.
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“Choosing not to engage with China is no choice at all,” she wrote in The Times, emphasising the need for pragmatic solutions.
What lies ahead?
As financial markets remain volatile, the Labour government’s room for manoeuvre is shrinking. Reeves is expected to outline a revised fiscal strategy in her March 26 address to Parliament. The update will coincide with the Office for Budget Responsibility’s latest forecasts, which could further constrain government spending plans.
While some experts urge caution, others strike a note of optimism. “Financial markets can be wracked with volatility, but over the longer term, these fluctuations tend to even out,” Streeter said.
The coming months will test the resilience of Starmer’s government. With borrowing costs at historic highs and the economy teetering on the edge, difficult decisions lie ahead. Whether Labour can maintain its progressive agenda while navigating these turbulent waters remains to be seen.
