Rachel Reeves Faces Fiscal Headwinds as Bank of England Stands Firm on Rates and Bond Sales

Rachel Reeves, the Chancellor, is confronting a significant fiscal challenge as she prepares for her autumn Budget. With the government needing to plug a gap of between £20bn and £50bn through tax rises and spending cuts, the pressure is mounting to find credible solutions that will restore balance to the nation’s finances. Andrew Bailey, Governor of the Bank of England, has held firm, offering little reprieve through monetary policy or support in the debt markets.

While lower borrowing costs and increased demand for government debt might help ease the strain of the UK’s £2.9 trillion national debt, the Bank of England signalled on Thursday that such relief will not arrive soon. In contrast to the recent rate cut by the US Federal Reserve – which dropped rates to 4.25 percent – the Bank opted to keep interest rates at 4 percent, with Bailey emphasising a need for caution in future reductions. With inflation expected to hit 4 percent, twice the Bank’s target, food price pressures and persistent high wage growth remain particular concerns. Investors are doubtful of any rapid rate cuts, with expert opinion suggesting the next reduction may not come until early 2026.

The Office for Budget Responsibility now faces sustained high debt interest costs as a result of the Bank’s stance. Despite poor economic performance, which would typically slow price growth, inflation remains sticky. Reeves’s previous policy moves, such as the £25bn increase in employers’ National Insurance contributions and a 6.7 percent rise in the minimum wage, have contributed to upward pressure on business costs and prices, according to the Bank’s agents who consult with businesses nationwide. Changes to inheritance tax have also added to the worries of family-owned firms, lessening their appetite for investment.

With uncertainty building ahead of the Chancellor’s autumn Budget, business sentiment remains subdued and hopes for a recovery in activity have been pushed into 2026. There are warnings of a potential doom loop for the UK economy: slow growth widens the Budget deficit, forcing tax increases or deeper spending cuts, which in turn weigh further on growth, perpetuating the cycle.

The Bank’s ongoing quantitative tightening process compounds the problem. While the pace of balance sheet reduction will slow to £70bn over the next year – down from £100bn – the need to sell a larger amount of bonds actively (£21bn, up from £13bn last year) increases the risk of higher borrowing costs and potential market losses that the Chancellor must cover. The Bank’s decision to reduce sales of long-dated bonds provides some relief, as it helps keep long-term borrowing costs contained at a time of global investor concerns over government debt levels.

Despite this slight mitigation, the Bank’s latest decisions do little to alter the reality confronting Reeves. Tens of billions in extra revenue or savings must still be found if the government is to keep its fiscal promises. For now, the Chancellor will need to confront these tough choices without significant support from Threadneedle Street.