(Bloomberg) -- UK Chancellor Rachel Reeves is refusing to recommit to a pledge made in November not to change her debt target amid speculation she is preparing to ramp up borrowing to fill a £16.4 billion ($21 billion) hole in the public finances.
Reeves desperately needs some money after claiming this week that the previous Conservative government bequeathed her a litany of “unfunded and undisclosed” spending commitments. She has already warned that taxes will need to rise in October when she delivers the first budget of the new Labour government.
Her room to spend more to fix Britain’s ailing public services is constrained by a commitment to have the national debt falling as a share of the economy in five years. However, she could release extra an £16 billion of borrowing headroom simply by targetting a different measure of debt, an option some economists and Conservatives believe is under consideration. Some economists calculate that the saving could be as high as £20 billion.
“We expect them to do it in the budget, partly because there is limited time for it to be worthwhile and partly because they need the extra spending headroom,” said Andrew Goodwin, chief UK economist at Oxford Economics.
The Conservatives had the same fiscal rule, based on debt excluding the Bank of England. That gave the government less than £9 billion of headroom, the Office for Budget Responsibility estimated in March. The margin would have been almost £25 billion had total public sector net debt been used instead.
Last November, Reeves told reporters she was “not going to fiddle the figures or make something to get different results” when asked whether she would consider using the easier debt target. “We will use the same models the government uses,” she said.
But the chancellor did not respond when challenged this week by her predecessor and opposite number Jeremy Hunt. “Will she confirm that in order to pay for her public spending plans, she will not change her fiscal rules to target a different debt measure, so she can increase borrowing and debt by the back door?” Hunt said in Parliament.
Asked if the November commitment held, a Treasury spokeswoman simply reiterated that the fiscal rules are “non-negotiable” and declined to comment on which measure the chancellor is targeting. “The fiscal rules will be published alongside the budget on October 30.”
A switch to PSND would allow Reeves to borrow tens of billions of pounds more over the parliament but is unlikely to be controversial. It was used between 2010 and 2021 and “markets would be pretty pragmatic about it,” Goodwin said.
PSND excluding the BOE was adopted in 2021 because it removed distortions caused by the central bank’s cheap funding scheme for lenders during the pandemic.
However, the measure is now creating a problem due to the heavy losses the BOE is taking on its quantitative-easing portfolio of government bonds, which peaked at £895 billion but has been reduced to £691 billion so far in a process known as quantitative tightening. The bulk of the losses, which are covered by the Treasury, are already accounted for in the PSND measure.
“This is something completely out of the chancellor’s control and is having a massive effect on her spending plans,” Goodwin said. “It makes a lot of sense to move to PSND. It does not look right for the fiscal position to seem to be in the hands of the BOE.”
The scale of losses wrought by QT is determined by the pace at which the gilts are sold by the bank. That interaction with the Treasury has also caused problems for the BOE. Officials would like the debt target changed to depoliticize its policies, according to one person familiar with its thinking.
“If you maintain the current system, there appears to be an incentive for the Treasury to lean on the bank to change its plans,” Goodwin said.
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