Weak economy 'means tax hikes & spending cuts now likely'

Chancellor is likely planning to hike taxes "at least one more time" after a spate of unconvincing economic data, economists warn.

The Government will likely need to raise taxes again this year, according to research by Deutsche Bank. 

The investment bank anticipates a “painful sequel” to Chancellor Rachel Reeves’ Budget last year, as it expects growth to dip below the Office for Budget Responsibility’s (OBR) October projections following recent poor economic figures. 

The financial markets were previously pricing in two interest rate cuts for 2025, but City traders have since trimmed their bets on these. As such, Deutsche Bank now says it expects “big revisions” to the OBR’s economic forecasts.  

The UK economy shrunk by 0.1% in October – the second consecutive monthly contraction.  

“As a result, more borrowing and tax rises, we think, will be likely this year,” said Sanjay Raja, the bank’s chief UK economist.

“We think Chancellor Reeves will likely need to lift taxes at least one more time following last year’s historic tax-raising event.”

Meanwhile, a Financial Times survey of 96 leading economists has also warned that tax rises could be on the horizon, despite previous forecasts that the UK could return to growth in 2025. 

Reeves aimed to raise £40 billion in her October Budget, partly to fill what she claimed was a £22 billion black hole inherited from the previous Conservative Government. 

The Treasury previously said there would be no tax changes in the Spring Budget on 26 March.

“We are never going to need a Budget like this again,” Reeves told a Treasury Committee meeting in November, adding she would not increase taxes again in this parliamentary cycle.

The Consumer Price Index measure of inflation jumped to 2.6% in November – the highest figure since March – and the Bank of England held interest rates at 4.75% due to "heightened uncertainty in the economy". 

Government spending cuts expected

Meanwhile, analysts at Capital Economics predict more Government spending cuts could also be on the horizon as the cost of long-term borrowing hit a 28-year high. 

The interest rate on gilt yields – the rate at which investors hold UK public debt – hit 5.25% this week. 

Analysts say the additional public borrowing costs could mean the Chancellor is at risk of breaking her fiscal rules, leaving her with less money for public services. 

"There is a significant chance that the Office for Budget Responsibility (OBR) will judge that Chancellor Rachel Reeves is on course to miss her main fiscal rule when it revises its forecasts on 26 March,” said Ruth Gregory, the deputy chief UK economist at Capital Economics.

“To maintain fiscal credibility, this may mean that Reeves is forced to tighten fiscal policy further." 

IFS warned Government spending was too ‘front-loaded’

Following the Autumn Budget, the Institute for Fiscal Studies (IFS) warned that the Government’s spending was too “front-loaded” and that further tax hikes could be necessary. 

“There are big risks lurking in this Budget,” wrote Paul Johnson, director of the IFS, in October last year.

“Big increases in taxes and borrowing are not costless… I’d be surprised if the spending plans after 2025-26 survive contact with reality.

“The most remarkable thing about this Budget was just how front-loaded the spending commitments are. Loads of extra money this year and next.”

Indeed, the Chancellor allocated a spending increase of 4.3% in 2024-25, 2.6% in 2025-26 but just 1.3% from 2026 to 2029 – lower than the previous Labour Governments or even during Boris Johnson’s term in office. 

“But after 2025-26 we have day-to-day public service spending rising by a miserable 1.3% a year,” said Paul Johnson. “That may not even be enough to avoid cuts to some departmental budgets.”

Johnson added that it looked “horribly like a repeat” of the strategy of Rishi Sunak’s Conservative Government. “Make it look like the fiscal numbers add up by being generous this year and pencilling in implausibly tight spending plans later on,” he explained. 

Households will feel the pain of any tax hikes 

Regardless of what kind of tax increases or public spending cuts may be implemented by the Government, it’s unlikely the average household will escape the consequences  – as we have seen with the recent Budget 

While the Labour Party promised in its election manifesto not to raise taxes for ‘working people’, the recent increase in National Insurance payments for employers has already led to price increases for customers and fewer or lower pay rises for staff. 

Most businesses say they expect to hike prices in 2025, following the increase in National Insurance payments, according to Grant Thornton’s business outlook tracker. 

According to the survey, 54% of respondents said they would need to pass increased employment costs onto consumers through higher prices. 

Meanwhile, 52% of the 800 UK firms surveyed said they planned to reduce hiring, offer smaller pay packages or cut roles altogether to save money. 

Schellion Horn, who led the research at Grant Thornton, said this would "put pressure on inflation" and mean interest rates remain higher for a more sustained period. 

"Just when there is light at the end of the tunnel, the market is now faced with further cost increases," she said.