Economists predict higher taxes and borrowing after UK deficit overshoots forecasts

Introduction: UK borrowing hits £3.1bn in July

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The health, or unsoundness, of Britain’s public finances is a key issue for Westminster and the City of London, with a painful autumn budget looming.

And the latest public finances data, just released, shows that the UK borrowed more than twice as much as economists expected last month to balance the books.

Public borrowing hit £3.1bn in July, which is £1.8bn more than in July 2023. It’s the highest July borrowing since 2021 (when the Covid-19 pandemic drove up spending and hit tax revenues).

City economists had expected lower borrowing, of £1.5bn.

Crucially, the fiscal watchdog, the Office for Budget Responsibility, had estimated the UK would only need to borrow £100m in July – which is typically a strong month for tax receipts, such as income tax self-assessment returns.

So, the black hole in the public finances which chancellor Rachel Reeves warned of in July has just got deeper.

A chart of UK borrowing — Photograph: ONS

Although the tax take increased in July, this was more than wiped out by higher government spending.

ONS deputy director for public sector finances, Jessica Barnaby, explains:

“July borrowing was almost £2 billion higher this year than in 2023. Revenue was up on last year, with income tax receipts in particular growing strongly. However, this was more than offset by a rise in central government spending where, despite a reduction in debt interest, the cost of public services and benefits continued to increase.”

The ONS has also revised some of its earlier public finances data, which has reduced its estimate of borrowing since April by £1.5bn,. It now estimates the UK has borrowed £51.4bn so far this financial year.

That’s £500m less than was borrowed in the same four months last year, but £4.7bn more than the £46.6 billion forecast by the OBR for this period.

A chart showing UK public finances Photograph: ONS

This increase in borrowing intensifies the pressure on Rachel Reeves to make tough decisions in her first fiscal event, this autumn.

As the Guardian reported last night, the chancellor is planning to raise taxes, cut spending and get tough on benefits in October’s budget as she tries to fill a substantial black hole in the public finances – despite stronger than expected growth in the first half of 2024.

Reaction to follow….

The agenda

7am BST: UK public finances for July
9am BST: South Africa’s inflation report for July
Noon BST: US weekly mortgagea approvals data
3.30pm: EIA to release US crude oil inventory data
7pm: Minutes of July’s Federal Reserve interest-rate setting meeting released

Key events

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Rob Wood, chief UK economist at Pantheon Macroeconomics, says:

“We expect … Reeves to borrow around 20 billion pounds per year more than planned in the March Budget for the next five years as well as funding medium-term spending with higher taxes.”

IFS: Reeves faces ‘tough choices’ in the budget

Today’s public finances show that the UK’s decent-looking growth rate this year does not mean that everything is rosy in the economy.

Isabel Stockton, senior research economist at the Institute for Fiscal Studies, explains:

Tax revenues – despite economic growth in the first quarter of the financial year surpassing some of the more pessimistic expectations – are running close to forecast or, if anything, slightly behind. This, combined with higher spending, leaves borrowing higher than forecast.

Stockton adds:

All of these data are preliminary and we should be cautious of over-interpreting them. But the early signs are that better-than-expected growth figures won’t be enough save Rachel Reeves from tough choices in her first Budget on 30 October.

The combination of in-year spending pressures identified at last month’s spending audit and the ongoing, and well known, pressures facing many public services suggest that the accompanying spending review for 2025-26 could be a particularly difficult exercise.”

Capital Economics predicts Reeves will raise taxes and increase borrowing

July’s public finances figures continued the recent run of bad news on the fiscal position, says Alex Kerr, UK economist at Capital Economics.

Kerr reckons that public borrowing is track to overshoot the OBR’s 2024/25 forecast of £87.2bn by £4.7bn.

Even if this overshoot does not persist, Capital Economics expect the Chancellor to raise taxes and increase borrowing at the Budget on 30^th October.

Kerr explains:

Overall, today’s release highlights the tight fiscal backdrop that the Chancellor faces ahead of her first Budget on 30^th October. We still think that she will look to raise an additional £10bn a year via higher taxes in the Budget and increase borrowing by around £7bn a year.

The increase in borrowing in July leaves Rachel Reeves with “little headroom” ahead of October’s budget, warns Dennis Tatarkov, senior economist at KPMG UK.

“Borrowing in July was ahead of OBR forecasts and could rise further if the announced overspend makes its way into the revised figures. This could take borrowing for the 2023-24 fiscal year to over £90bn if significant savings cannot be found.

“Strong GDP growth in the first half of the year has helped bring higher than expected revenues, which in July were £99.4bn and ahead of projections made during the March Budget. However, an expected slowing in GDP growth ahead could limit revenues in the second half of the year.

“We estimate the headroom that the Chancellor has to meet current fiscal rules has shrunk further, down to £6bn from £9bn in March. This may mean that the targets themselves could see a tweak in the upcoming Autumn Budget.”

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UK spent £7bn of debt interest in July

Britain spent £7bn paying interest on the national debt in July.

That’s the second highest interest payable in any July since records began in 1997, the ONS says.

That’s lower than the £8bn interest bill in July 2023, though, as falling inflation lowered the debt bill on index-linked bonds.

Photograph: ONS

Government expenditure jumped by £3.5bn year-on-year in July – more than cancelling out the increase in tax – to £107.4bn.

This was primarily due to a £2.7bn increase in benefits, linked to inflation.

There was also a £1.3bn rise in central government departmental spending, as inflation and pay rises increased running costs.

Digging into July’s public finances, we can see that higher tax receipts lifted central government’s income to £91.0bn in July – £1.7bn more than in July 2023.

Tax receipts increased by £2.1bn to £71.2bn, including a £1.7bn increase in income tax receiptes, £300m more in corporation tax, and £200m of VAT.

But, there was a £1.1bn drop in “compulsory social contributions”, to £13.8bn, due to the reductions in the main rates of National Insurance made by former chancellor Jeremy Hunt.

Self-assessment tax receipts rose by £1.1bn year-on-year to £12.9bn. However, that’s £700m less than the OBR had forecast (one reason the deficit was much higher than the £100m expected by the fiscal watchdog).

Darren Jones: We’ve been left with a dire inheritance

The jump in UK government borrowing last month shows the “dire inheritance” left by the previous government, says chief Secretary to the Treasury Darren Jones:

“Today’s figures are yet more proof of the dire inheritance left to us by the previous government.

“A £22 billion black hole in the public finances this year, a decade of economic stagnation and public debt at its highest level since the 1960s, with taxpayers’ money being wasted on debt interest payments rather than on our public services.

“We are taking the tough decisions that are needed to fix the foundations of our economy, modernise our public services and rebuild Britain so we can put more money back into people’s pockets across the country.”