Walking the Fiscal Tightrope: Can the UK Government Spend Its Way to Growth Without Losing the Bond Market's Trust?

On the morning of 30 October 2024, Rachel Reeves stood at the dispatch box and delivered the largest fiscal loosening since the pandemic. The Autumn Budget raised day-to-day spending, announced a £100 billion capital investment programme over five years, and redefined the fiscal rules in a way that permitted borrowing for investment to rise substantially. The gilt market's initial reaction was telling: yields moved sharply higher as investors absorbed the implications of a significantly expanded borrowing requirement.

Seventeen months later, the government is still navigating the consequences of that moment. Gilt yields have remained elevated, the fiscal headroom against the Office for Budget Responsibility's (OBR) forecasts has been repeatedly squeezed, and the growth dividend that was supposed to justify the investment splurge has been slow to materialise. The fundamental tension at the heart of UK fiscal policy — between the investment the economy needs and the market confidence that makes borrowing affordable — has not been resolved. It has merely been deferred.

The Starting Point: How We Got Here

Understanding the current fiscal position requires understanding the extraordinary sequence of shocks that shaped it. The UK entered 2020 with public sector net debt at around 80% of GDP — already elevated by the post-2008 austerity debate — and exited the pandemic with it above 100%. The subsequent energy price shock required further emergency spending. By the time of the 2024 Budget, the fiscal inheritance — whatever political characterisation one attaches to it — was genuinely constrained.

The government's response was to reframe the question. Rather than asking "how do we reduce borrowing?", the 2024 Budget asked "how do we borrow more productively?" The new fiscal rules distinguished between current spending — which had to be covered by revenues within the forecast period — and capital investment, which could be debt-financed on the grounds that it generates returns over time. The approach had intellectual credibility; the question was always whether the bond market would buy it.

What Gilt Markets Are Saying

The UK government borrows by issuing gilts — bonds of various maturities sold to investors, principally domestic pension funds and insurance companies, overseas central banks, and international asset managers. The yield on a gilt represents the cost of that borrowing: when yields rise, the cost of financing the national debt increases, and the headroom against the fiscal rules narrows.

The 10-year gilt yield today stands at approximately 4.7% — elevated by historical standards and, crucially, above the level assumed in the OBR's most recent forecasts. Every 10bps increase in gilt yields relative to forecast erodes fiscal headroom by several billion pounds over the five-year forecast horizon, as the cost of refinancing maturing debt rises and the interest bill on new borrowing increases.

The comparison most frequently invoked — and most frequently denied — is with the September 2022 mini-Budget crisis, when a combination of unfunded tax cuts and poor communication with the bond market sent gilt yields spiralling and forced the Bank of England into emergency intervention. The current situation is meaningfully different: the increases in borrowing are OBR-certified, the Bank has not needed to intervene, and the global context — with US Treasury yields also elevated — accounts for some of the rise.

But "different from September 2022" is a low bar. The more relevant question is whether current gilt yields are consistent with the government's fiscal plans remaining credible, and the answer to that is increasingly uncomfortable.

The Growth Assumption Problem

The government's entire fiscal strategy rests, ultimately, on an assumption about growth. If the UK economy grows at or above the OBR's forecast rate, tax revenues come in as expected, the debt-to-GDP ratio stabilises, and the investment programme looks prescient. If growth disappoints — as it has consistently done over the past decade — the arithmetic deteriorates.

The OBR currently forecasts UK GDP growth of 1.6% in 2026 and 1.8% in 2027. These are not heroic assumptions by historical standards, but they do require a meaningful acceleration from the 0.8% recorded in 2025 — and they embed assumptions about business investment and productivity that have a poor recent track record of being realised.

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The government is betting that borrowed money, invested well, generates returns that justify the borrowing. It is a reasonable bet. It is not a guaranteed one.

The growth model implicit in the strategy has three components. First, public capital investment — in infrastructure, clean energy, and housing — crowds in private investment by reducing supply-side bottlenecks and improving returns on private capital. Second, a more stable policy environment (relative to the frequent U-turns and volatility of the 2019–2024 period) rebuilds business confidence and encourages long-term investment decisions. Third, structural reforms — planning liberalisation, skills policy, trade facilitation — improve the economy's supply capacity over the medium term.

Each of these mechanisms is theoretically sound. The question is timing. The fiscal rules require debt to be falling as a share of GDP by the end of the five-year forecast period. The supply-side benefits of infrastructure investment, by contrast, accrue over decades. There is an inherent tension between the short-term horizon of fiscal rules and the long-term horizon of productive investment that no formulation of those rules fully resolves.

The Employer National Insurance Problem

One significant complication has emerged from the Budget itself. The increase in employer National Insurance contributions (NICs) — a 1.2 percentage point rise in the rate combined with a lower threshold — was the single largest revenue-raising measure in the Budget, projected to raise approximately £25 billion per year.

The early evidence suggests it is having effects that were not fully captured in the OBR's scoring. Business surveys, particularly among labour-intensive sectors — hospitality, retail, social care — show a sharp reduction in hiring intentions and an acceleration in automation investment as firms seek to reduce their exposure to labour costs. There are early signs of pass-through to wages, with some employers holding pay settlements below what they would otherwise have been in order to offset the NIC increase.

None of this is necessarily catastrophic. Labour markets adjust to tax changes. Automation investment, even if partly driven by tax avoidance, adds to the productive capital stock. But the fiscal arithmetic assumes the revenue yield is as scored, and the growth forecast assumes the labour market continues to function smoothly. If the NIC increase is more contractionary than assumed, both of these assumptions are simultaneously challenged.

Spending Discipline and the Departmental Squeeze

The fiscal rules require current spending to be met from revenues. With the NIC increase providing a substantial revenue boost and day-to-day departmental spending having been raised in the Budget, the implication is that the government has, for now, created room to deliver on its spending commitments.

But the composition of that spending matters. Public sector pay — which accounts for the largest share of day-to-day departmental expenditure — has been running ahead of private sector pay growth in some segments, reversing a decade of relative public sector pay compression. NHS waiting list reduction requires sustained investment in staff and facilities. Defence spending has been increased to 2.5% of GDP.

The arithmetic of satisfying these competing demands while maintaining fiscal credibility is tight. The OBR's numbers work — but they work with essentially zero headroom. A modest negative surprise on growth, a worse-than-expected debt servicing cost, or a policy decision to spend more in one area without offsetting savings in another would put the fiscal rules in jeopardy.

What Losing the Bond Market Would Look Like

It is worth being precise about the risk. "Losing the bond market" does not mean overnight catastrophe — the UK is not Argentina. It means a gradual, difficult-to-reverse deterioration in borrowing costs that makes the fiscal position progressively less sustainable and ultimately forces a more painful adjustment than would have been required if action had been taken earlier.

The transmission mechanism runs roughly as follows: growth disappoints and/or fiscal headroom is exhausted by an unexpected spending commitment; the government faces a choice between announcing spending cuts (politically very difficult mid-parliament) or revising the fiscal rules (credibility-damaging); gilt yields rise as investors demand compensation for increased fiscal uncertainty; higher gilt yields reduce headroom further; a negative feedback loop develops.

The analogy — imperfect but instructive — is not the 2022 mini-Budget but the UK's exit from the Exchange Rate Mechanism in 1992, or France's fiscal difficulties in 2024: a slow-burn loss of market confidence driven by fundamental economic weakness rather than a single policy shock.

Our Assessment

The government's fiscal strategy is coherent. The distinction between current and capital spending is intellectually defensible. The investment programme, if well executed, could make a meaningful difference to the UK's long-run supply capacity. The political argument — that growth requires investment, and investment requires borrowing — is not wrong.

But coherence is not the same as credibility, and credibility is ultimately what matters in gilt markets. The strategy requires a fairly precise combination of circumstances: growth at the upper end of the plausible range, gilt yields that stabilise or fall as global monetary policy eases, no significant external shocks, and discipline in the face of pressures to spend more or tax less.

The task ahead is not impossible. But the margin for error is thin, and it is getting thinner. The government would do well to remember that bond markets, unlike voters, do not wait for the next election.