Rachel Reeves is set to push ahead with plans to borrow billions of pounds for infrastructure investment, despite rising government debt costs.
Reeves intends to change how the Treasury accounts for capital spending to reflect its benefits, a move that could be confirmed to the Office for Budget Responsibility as early as Wednesday, reports show.
This change in accounting methods is expected to allow the government to borrow tens of billions more for capital spending over the course of this parliament.
The decision comes amid concerns about the recent increase in UK Government borrowing costs. Since mid-September, the annual interest rate on a 10-year government bond has risen from 3.75 per cent to 4.2 per cent.
However, some experts argue that this rise is more connected to the US economy than to concerns about Reeves’ budget plans.
Reeves briefed the cabinet on Tuesday about her budget plans, emphasising the importance of capital spending for the economy. Labour has pledged to balance day-to-day expenditure with tax receipts and reduce debt as a share of the economy.
To achieve this while increasing investment, Reeves is exploring alternative debt metrics. One option under consideration is changing the debt measurement to account for the value of government-held assets, such as roads, schools, and hospitals. This could potentially free up £50billion for borrowing.
The decision comes amid concerns about the recent increase in UK government borrowing costs
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Another options is potentially accounting for the value of Government-held assets like roads, schools, and hospitals. However, a more modest approach is also being considered.
This would involve excluding Bank of England losses from debt calculations and any extra borrowing used to establish public institutions like the national wealth fund.
This could free up between £10billion and £20billion for investment, while being less likely to trigger sharp rises in borrowing costs and interest rates.
A Treasury analysis from December indicated that a fiscal loosening of one per cent of GDP could lead to a peak increase in interest rates of up to 1.25 per cent.
The Institute for Fiscal Studies echoed this concern, warning that borrowing an extra £50 billion in 2028-2029 could have a “material impact on interest rates”.
Alongside increased borrowing, Reeves is also working on tax rises, including VAT on private school fees and tightening rules for non-doms. However, shifting projections on potential revenue from these measures have added pressure to change the debt definition.
Market reactions to Reeves’ plans have been mixed. Mark Dowding, chief investment officer at RBC BlueBay Asset Management, warned in the Financial Times that Reeves “needs to walk a tightrope, otherwise the gilt market will limit her ability to deliver much of Labour’s agenda.”
However, Mohamed El-Erian, chief economic adviser at Allianz, told BBC Radio 4 that the rise in UK borrowing costs is more likely due to global factors, noting that US interest rates have increased by the same amount.
Rupert Harrison, a former adviser to George Osborne, cautioned that while small changes to debt definitions may not alarm markets, the context is crucial given the UK’s current fiscal rules and vulnerability to market dynamics.
Some ministers have expressed concern about potential short-term capital spending cuts to address an immediate £22billion shortfall in this year’s accounts.
Despite plans to increase investment, historical data suggests implementing higher capital spending may prove challenging.
The Office for Budget Responsibility (OBR) has warned that successive Governments have found it “particularly difficult” to deliver quick increases in capital spending, even when budgets are increased substantially.
The OBR’s analysis of 22 investment plans between 1998 and 2007 showed spending fell short on 19 occasions. This pattern of underspending has persisted, with the OBR noting that investment budgets are “almost always underspent”.
Gemma Tetlow, chief economist at the Institute for Government, explains: “It may seem surprising that departments underspend on their budgets, but there are incentives to undershoot.
“The Treasury controls departmental spending tightly, and ministers and permanent secretaries face reputational costs if they overspend.”
These historical challenges could potentially hinder Reeves’ plans to “invest, invest, invest” in infrastructure projects.