Rachel Reeves fiscal buffer at risk from Uturns and lower migration

Recent market assessments have raised concerns regarding the sustainability of Chancellor Rachel Reeves’s newly established fiscal buffer. Originally set at £22 billion, projections suggest that as much as £14 billion could potentially be eroded due to a series of recent government Uturns and diminishing net migration.

The fiscal headroom represents the surplus tax revenue generated by the government, exceeding its spending obligations. As part of her strategy, Reeves aimed to bolster this fiscal surplus, following significant tax increases amounting to £26 billion. These measures included an £8 billion multi-year extension to the freeze on income thresholds, effectively more than doubling the previously allocated safety net.

In a concerning turn of events, calculations from Bloomberg indicate that recent policy changes may jeopardise this financial buffer. Following pushback from numerous pubs that banned Labour MPs in protest, the government has opted to ease business rate increases within the sector, which could cost the Treasury approximately £300 million. In tandem with this, efforts to raise the threshold for farmland inheritance tax have resulted in an additional financial strain of around £130 million.

Furthermore, a marked decline in net migration poses a significant threat to tax revenues. Current forecasts suggest that net migration to the UK may fall short by 100,000 individuals annually, a reduction that could diminish tax revenues by an estimated £9 billion by financial year 2029-30. This decline raises critical concerns, as economically active migrants are known to provide substantial benefits to the economy.

Significantly, the Prime Minister also risks failing to meet his commitment to increase military spending to 2.5 per cent of GDP by 2027, and subsequently to 3 per cent in the following parliamentary term. Reports indicate a potential funding shortfall of £28 billion over the next four years, averaging £7 billion per year.

Despite initial approval from financial markets regarding the Chancellor’s wider fiscal headroom strategy, the recent developments threaten to undermine this positive sentiment. UK bond yields have experienced a quicker decline than comparable countries’ debt yields in recent months, raising further questions about the overall stability of the fiscal landscape.