Borrowing pressures and bold choices: The UK's economic crossroads

The UK is facing a significant economic challenge as borrowing costs surge, driven by rising gilt yields. Gilt yields, the interest rate investors demand for lending to the government, have climbed sharply in recent months. This trend reflects global factors such as tighter monetary policy by central banks (and the impending return of a familiar figure to the White House) alongside domestic concerns about economic underperformance and whether the government’s promised growth will materialise.

Higher gilt yields directly translate to increased borrowing costs for the government, placing strain on public finances. This development complicates Chancellor Rachel Reeves’ plans for ambitious public spending initiatives. Reeves has consistently emphasised the importance of fiscal responsibility, promising not to borrow for day-to-day spending. However, her vision for "securing economic growth through green investment" could face constraints as higher borrowing costs make funding large-scale infrastructure and renewable energy projects more expensive.

There have been some eye catching  - and potentially controversial – proposals for how the government can move to turn this challenge around. Journalist Duncan Weldon proposed in the New Statesman that the government could look at raising VAT, a move he argues would be an easier political sell than a menu of smaller changes, each of which could have the potential to open up different campaigns of opposition. 

While Labour pledged before the general election that it would not increase the rates of VAT, income tax or employee national insurance contributions, he makes the point that if the government needs to find another revenue raiser, a one percent increase in VAT would deliver around £9bn. And, as he notes, 20% VAT is a “core component of the progressive welfare systems found in Denmark, Sweden and Norway.”

Whether or not the Chancellor opts for a sweeping and bold solution like this one, navigating the current pressures requires deft economic management. The government will need to prioritise its agenda carefully, demonstrating that long-term investment can deliver economic growth and higher tax revenues to offset initial costs. As the UK grapples with rising borrowing costs, the political stakes for Reeves and the Labour government have never been higher. Their ability to adapt could define their success in office.

The political debate will certainly be an interesting – and fraught. Expect to see the government making the case that the reason for the current predicament is in part due to the UK’s failure to invest in upgrading our national infrastructure during the extended period of low borrowing rates available in the 2010s. As political historian Dr Colm Murphy recently noted one irony is that fiscal constraint suited the politics of that decade but not the economics...and unless something changes fast, the reverse may now be the case.