Britain’s public finances gave the Chancellor some rare good news this week: national debt fell to its lowest level in four years in March. But business leaders and economists are already expecting the numbers to worsen, warning that the escalating conflict in the Middle East could quickly unravel Rachel Reeves’ carefully laid financial plans.
According to figures released on Thursday by the Office for National Statistics, the government borrowed £12.6 billion last month, the lowest March total since 2022 and £1.4 billion less than the same month last year. The fall was driven by a sharp fall in debt interest spending and a record £100 billion rise in tax revenue.
For small and medium-sized businesses that continue to bear the burden of frozen income tax limits, higher employer social security and stubborn inflation, the numbers are little consolation. While the Treasury has moved closer to its borrowing targets, the improvement is due less to Whitehall’s restraint and more to a quirk of the retail price index.
Despite the monthly improvement, the figure in March was above City economists’ consensus forecast of £10.4 billion. Borrowing for the full financial year reached £132bn – £700m less than the Office for Budget Responsibility forecast, but still the sixth highest annual total since records began in 1947. The figure was still almost £20bn lower than the previous year.
The headline decline was flattered by a dramatic fall in debt interest costs, which fell from £13bn in February to £3.2bn in March and £4.5bn in the same month last year. A significant portion of Britain’s debt remains tied to the retail price index, a measure that economists have long dismissed as outdated. A sharp slowdown in RPI between December and January led directly to lower payments to index-linked gilt holders.
Tax revenue also did much of the heavy lifting. Public sector revenue rose by £5.4bn year-on-year and passed the £100bn threshold in March, driven by higher income tax and national insurance receipts. Public spending rose more modestly, rising by £2.9 billion to £91.6 billion.
Tom Davies, chief statistician at the ONS, said the figures showed that “although spending has increased this financial year, this has been more than offset by higher income”, pointing out that borrowing was 10 per cent lower in March than a year earlier.
But optimism was tempered by warnings that last month’s tailwinds could quickly reverse. Economists fear that the war in the Middle East is already having an impact on British inflation and growth forecasts and threatens to limit the Chancellor’s room for maneuver.
“A sustained rise in energy prices would lead to double pressure on public finances,” said Martin Beck, chief economist at WPI Strategy. “While higher oil and gas prices could boost North Sea revenues, while higher inflation could boost VAT revenues and income tax revenues above frozen thresholds, these gains would likely be outweighed by weaker economic growth and higher spending pressures, including higher social costs, rising debt interest payments and possible support for households and energy-intensive businesses.”
Figures released earlier this week showed consumer price inflation rose to 3.3 percent in March from 3 percent in February. Some economists now expect the peak to reach double the Bank of England’s 2 percent target later this year, a development that would push up the government’s debt interest bill again and put new pressure on already struggling SMEs.
The bank’s nine-member monetary policy committee meets next Thursday and is widely expected to keep the key interest rate at 3.75 percent. However, a minority of analysts now believe that Threadneedle Street could be forced to raise interest rates later in the year to counter the inflationary impact of the Middle East. Updated forecasts for inflation, growth and unemployment will accompany the decision.
The share of debt in gross domestic product was 93.8 percent, an increase of 0.6 percentage points compared to the previous year and again at a level not seen since the 1960s.
The picture could quickly deteriorate. The Resolution Foundation warned in a report this month that further escalation in the Middle East war could wipe out £16 billion of the £23.6 billion fiscal space that Reeves outlined in its spring statement in March. Under her own budget rules, the Chancellor must balance daily spending with tax revenue within five years.
Ellie Henderson, economist at Investec, said: “The rise in energy prices has likely dampened the outlook, as higher inflation increases the cost of servicing index-linked government bonds and slower growth forecasts slow the growth of potential tax revenues.”
The Ministry of Finance, in turn, is eager to take advantage of loans. James Murray, chief secretary to the Treasury, said: “Our deficit has fallen (by) £19.8 billion because we plan to cut borrowing. In a volatile world, the decisions we are making are the right ones to keep costs down, regain our energy security and reduce borrowing and debt.”
For British businesses, and particularly the SMEs that make up the bulk of the country’s employers, the figures underline an uncomfortable truth: as favorable as March’s figures may seem, the margin of error has rarely been lower.
