Affinity Policy Comment 24 March 2025

Giving Up Growth For Lent

The spring equinox is finally upon us, bringing longer days and warmer weather – although a quick glance at the forecast in London dispels some of that optimism. British weather is notoriously hard to predict, but what can be guaranteed is that those of us in the UK will look on the gloomier side and find something to complain about. 

Here in Britain the arrival of spring also heralds the advent of the Chancellor’s Spring Statement – set for Wednesday – although in the run up announcements have certainly cast cloud. Just as with the weather, there will probably be plenty of disappointment with the upcoming fiscal event.  

The latest ONS figures reveal UK borrowing sharply exceeded expectations last month, with the Government spending £10.7bn more than it brought in, compared to the OBR’s forecast of £6.5bn. These unexpected figures represent the fourth highest February borrowing levels since records began in 1993, and come at a time when Britain has already been living beyond its means, with the deficit standing at £132.2bn in the year to February. Whilst many Labour MPs had been hoping for more spending on public services, to stay within her fiscal rules Chancellor Rachel Reeves may not have much freedom to sign off more funding, at least in the short term.

Reeves has set herself the task of balancing the budget by 2029-2030, and followed her maiden October budget with headroom of £9.9bn against her deficit rules. However, rising borrowing costs and low growth rates have all but eliminated this, and Reeves needs to show bond markets that she is keeping public finances in order, lest borrowing costs rise further.

Any hopes Reeves may have had for a pre-statement rate cut from the Bank of England have been dashed, as Threadneedle Street voted eight to one to keep interest rates at 4.5 per cent. BoE Governor Andrew Bailey argued that, whilst interest rates are on “a gradually declining path”, high levels of global economic uncertainty prevented a cut last week. The Government is thus stuck without relief on its sizeable debt interest bill, already consuming 2.9 per cent of GDP and outstripping key areas like education and defence. Perhaps worst on the inflation front, the Bank expects consumer price inflation to rise from 3 per cent in January to 3.75 per cent across the year – well above the 2 per cent target and squeezing households already struggling with the cost of living.

It’s improbable that Reeves can grow the UK’s way out of its predicament either. The latest OECD assessment forecasts 1.4 and 1.2 per cent growth in 2025 and 2026 respectively – 0.3 and 0.1 per cent down on December’s estimates. Further, the OECD expects UK inflation rates of 2.5 and 2.1 per cent for 2025 and 2026 – higher than those projected for other major European economies. To be fair, much of this is down to external factors like Trump’s tariffs, and aren’t unique to the UK, but that doesn’t illuminate the bleak outlook London faces. 

Nor is Reeves likely to be able to seriously boost taxation. Having stuck doggedly to pre-election promises not to raise income tax, employee National Insurance, or VAT, some have argued that Labour have boxed themselves into a corner by ruling out effective options to raise revenues. The Government squared this circle back in October by hiking employer NI contributions to 15 per cent and reducing the threshold at which employers pay the tax - changes expected to bring in £25bn a year. However, the policy has been widely criticised as damaging business confidence, with many employers planning to cut hiring and raise prices in response. Amid heightened asks on business, it’s not surprising that prospects aren’t looking good - a survey of 200 business leaders by the Adam Smith Institute found 77 per cent reported ‘low or very low’ confidence in the UK’s business environment, with the NI hike a particular concern. These tax changes come into force in April, so the impact in practice is yet to be seen, but the ‘jobs tax’ increase threatens to weaken business activity, causing knock-on effects on growth and ultimately hitting tax revenues.

That leaves cuts, which has been the option of choice in recent weeks. Faced with a different European security environment in the face of Trump 2.0, and a benefits bill set to spiral, the Government has been forced to trim expenditure on foreign aid and incapacity benefits, though have risked triggering rebellions from backbench Labour MPs. They’ve been able to do this successfully so far, but many have argued that the party’s promise of ‘no return to austerity’ is being jettisoned.

There are no easy options for Number 11 ahead of the Spring statement. But whatever happens after the Spring statement, the difficult economic environment will not be magically reversed by Government policy. It seems for the foreseeable future that Britain will have to just keep calm and carry on.

Elsewhere in UK policy, Prime Minister Keir Starmer has in recent weeks spearheaded plans for a ‘coalition of the willing’ to support Ukrainian security now that American support cannot be depended on. Together with French President Emmanuel Macron, Starmer had sought to build a ‘reassurance force’ of up to 30,000 troops to be stationed in Ukraine to deter future Russian aggression, and the pair deserve genuine credit for their efforts. However, the plan is struggling to get off the ground as European allies like Italy remain hesitant about sending ‘boots on the ground’, and others have proposed sending military assets and troops to backfill other parts of NATO sending soldiers.

Even Starmer has appeared to waver, changing the focus of potential UK support to air and naval assistance rather than sending soldiers – perhaps in recognition both at European reticence, and as Trump’s negotiations with Putin outpace European action. The latest from Washington is that the President has opened the door to taking control of Ukraine’s nuclear power plants while the minerals deal is still on the table in some form. Meanwhile the US has little interest in providing the ‘backstop’ to European security guarantees that Starmer so desperately seeks.

Whilst an end to the Ukraine conflict this year is looking increasingly likely, none of us know what the terms of the peace, or the long-term consequences will be. But it is increasingly evident that the postwar international order, if not already dead is collapsing day by day, leaving a more dangerous and less predictable world in its wake. At least there’ll be few dull moments in the times ahead.

Affinity Research LLP