Economists have warned that Chancellor Rachel Reeves will likely have to raise taxes or cut spending in March following the latest public finances update.
Figures from the Office for National Statistics (ONS) showed that tax receipts fell short of expectations in January due to the sluggish performance of the UK economy.
This means that in the financial year to date, borrowing hit £118.2bn, which was nearly £13bn more than the Office for Budget Responsibility (OBR) forecast in October.
This puts borrowing at its fourth highest level on record at this point in the year, pointing to the pressures facing the Chancellor as she seeks to firm up the public finances.
“The UK fiscal position remains a worry,” said Dennis Tatarkov, senior economist at KPMG UK.
“If the chancellor remains committed to her fiscal targets, then the Spring Statement may need to contain more tax and spending changes,” he added.
Reeves left a buffer of just under £10bn to meet her crucial fiscal target – ensuring day-to-day spending is funded out of tax receipts.
But economists think this headroom has evaporated due to sluggish growth and higher borrowing costs.
“It appears that all the Chancellor’s headroom has gone,” Elliott Jordan-Doak, senior UK economist at Pantheon Macroeconomics.
The OBR’s final forecast will only be released alongside the Chancellor’s spring statement, but Bloomberg reported that an early draft of the forecast suggests she will be in breach of her rules.
The government has repeatedly pledged that the fiscal rules are “non-negotiable,” which means Reeves will either have to raise taxes or plan for future spending cuts in March.
The government is also under growing pressure to lift defence spending to 2.5 per cent of GDP before 2030, up from 2.3 per cent at the moment. This would cost around £6bn per year.
Pantheon’s Jordan-Doak predicted the Chancellor would pencil in tighter public spending plans beyond 2025, but would likely have to increase taxes later in the year due to the need for more defence spending.
“We think the Chancellor will have to follow up spending curbs announced next month with tax increases in the Autumn Budget,” Jordan-Doak said.
Isabel Stockton, senior research economist at the Institute for Fiscal Studies said: “The Chancellor faces a truly unenviable set of choices – none of which are made easier by the upwards pressures on defence spending”.