Will Rachel Reeves have to go back on her word?

Elon Musk may have moved political focus in the UK to the grooming gangs scandal, but there is another issue causing alarm in the upper echelons of government this week: the economy. With every day that passes, Britain’s financial situation appears to be deteriorating. On Tuesday, a £2 billion auction of 30-year UK government debt sold at an interest rate of 5.198 per cent, which outpaced increases for other governments’ bonds. Ten-year borrowing costs have since surged to their highest level since the 2008 financial crisis, and as of today the pound continues to fall. On Wednesday, the Treasury put out a quote which has been seen as an attempt to calm the markets:

No one should be under any doubt that meeting the fiscal rules is non-negotiable and the government will have an iron grip on the public finances.

The Treasury spokesman added that Reeves would ‘leave no stone unturned in her determination to deliver economic growth and fight for working people’. Treasury sources are keen to downplay the idea that there is any panic on No. 11, or the idea that this is similar to the bond market response after Liz Truss’s mini-budget. Instead, they say they were responding to a query on whether the borrowing cost changes could impact Reeves’s headroom.

But if the rise in borrowing continues then Reeves faces a series of unappetising options. A sustained rise in servicing UK debt could wipe out Reeves’s headroom and see her break her own fiscal rules. In March, the Chancellor is due to present her ‘spring forecast’. Reeves previously suggested that the event on 26 March would not include any tax or spending changes as these will be saved for the autumn Budget each year. Yet if the OBR verdict for the spring forecast was a problem, the chancellor would be expected to take action to improve the situation.

The Treasury response on Wednesday is being read as a sign that Reeves will opt for spending cuts if her headroom goes and she needs to meet her fiscal rules through other means. This would of course be very unpopular with the Labour parliamentary party – already ministers are complaining about tight budgets. If higher borrowing eats up Reeves’s headroom, the spending review – due by early summer – will become more painful.

As expected, the opposition parties have been quick to go on the attack. Kemi Badenoch has called on Reeves to address parliament before she heads off to China on a charm offensive seeking closer economic ties. The shadow chancellor Mel Stride says ‘Labour’s decision to rack up higher debts is making it more expensive for the government to borrow’. In her first Budget as Chancellor, Reeves changed the borrowing rules on capital spending, meaning the UK government is expected to borrow £142 billion more over the next five years than they would have otherwise.

One of the factors making the markets jittery is the return of Donald Trump and what it could mean for the global economy. Even if Starmer and Reeves managed to avoid tariffs (this is no given), they face a headache on defence. As I write in this week’s politics column, Trump has said that he expects Nato members to up their spending to 5 per cent of GDP. ‘That means the realistic amount is 3 per cent at least,’ says a former defence secretary. ‘By the next Nato summit, with Trump there, it will be the main focus – and that is a nightmare for Rachel Reeves.’ As the new year gets underway, there is little for Reeves to feel positive about. Her best hope is that the bond market response will pass – and fast.

Reeves is expected to give more speeches and speak publicly in the coming weeks and months as she seeks to assure the markets and public that the government has a plan for growth. The Chancellor said after the October Budget that she would not go back with a begging bowl asking for more tax rises en masse. Unless something changes, Reeves could be forced back on her word.

Katy Balls, Kate Andrews and James Heale unpack the challenges facing Rachel Reeves in the latest Coffee House Shots podcast: