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Whitehall departments are bracing for harsher spending settlements this summer as the Treasury seeks savings following a jump in its borrowing costs.
Officials warned of “really difficult choices” in the upcoming spending review — with some departments warning it will be tough to withstand tighter spending given cuts in recent years.
“We’re already having to think about how we can do what we’re planning with even less,” said one Home Office official. “We are concerned.”
The official said comprehensive work on the spending review strategy had not started yet, but there was a growing worry in the department that their spending settlement would be cut.
There are fears that “we are going to have to look at how we can spend money more effectively or work with partners to see how we can make our money go further,” they added.
They added however, that Downing Street had acknowledged that the Home Office received a particularly “tough settlement” at the Autumn Budget — with a 3 per cent annual reduction in spending — giving hope that they might be spared some of the pain coming down the line at the next spending review.
An official in the education department also said increasing gilt yields — which reduce the government’s fiscal headroom — were raising the spectre of greater spending restraint in the coming months.
Another aide said it felt as though the markets were “testing” the Labour administration, adding that the government would need to demonstrate it was pushing ahead with cost-cutting plans to reassure investors that it could be trusted with the economy.
“There are going to be really difficult choices in the spending review in a few months time,” the person added.
The disquiet followed a surge in UK gilt yields that has by some estimates wiped out the chancellor’s headroom against the Treasury’s self-imposed fiscal rules.
Isabel Stockton, an economist at the Institute for Fiscal Studies, warned that recent increases in borrowing costs could easily erode most of the “razor-thin margin” against UK fiscal rules if they persisted.
The government sought to quell nerves in the financial markets on Thursday as Darren Jones, the chief secretary to the Treasury, insisted it would not breach its fiscal rules and that there remains healthy demand among investors for UK government debt.
During Thursday, the 10-year gilt yield rose as high as 4.93 per cent, its highest since 2008, before dropping to 4.81 per cent. The pound dropped as much as 1 per cent against the dollar to its lowest for more than a year.
Higher bond yields would impact estimates from the Office for Budget Responsibility of the government’s future bills on debt interest payments, which already exceed £100bn a year. The OBR is due to issue a forecast on March 26, which will be accompanied by a statement from Chancellor Rachel Reeves to Parliament.
Reeves was forecast to meet her key current rule, which excludes borrowing for investment, by a narrow £9.9bn margin according to estimates accompanying the October Budget. Analysts now believe that headroom has evaporated because of market movements — even before any changes to growth and inflation forecasts.
Jones told the Commons that the Treasury was working on its multiyear spending review due this summer on the basis of assumptions set out in the October Budget. Forecasts from the OBR would have an impact on discussions with ministers.
Additional reporting by Ian Smith in London
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