Rachel Reeves’ carefully crafted £22bn budget buffer could be eroded by up to £14bn by policy reversals and a sharper-than-expected fall in net immigration, raising new questions about the sustainability of the Chancellor’s budget strategy.
Markets initially welcomed Reeves’ November budget, which more than doubled the government’s fiscal space and was seen as a sign of discipline after months of worries about public finances. However, less than two months later, analysts warn that the margin of error is already narrowing.
According to Bloomberg calculations, a combination of relaxed tax measures and weaker migration-related revenues could reduce the buffer to just £8 billion by the end of the forecast period.
Fiscal space refers to the surplus between government revenue and spending in the target year, in this case 2029-30, which Reeves must maintain under her fiscal rules. In November the Chancellor increased taxes by £26 billion, including a multi-year extension of the income tax limit freeze by £8 billion, increasing the scope from £9.9 billion to £22 billion.
Since then, a series of reversals have begun to narrow that margin. Due to increasing pressure from the hospitality sector – including more than 1,000 pubs that Labor MPs have symbolically banned – the government has decided to scale back planned business rates increases for pubs, a decision expected to cost around £300 million.
Ministers have also relaxed proposed changes to inheritance tax on agricultural land and increased the threshold at which agricultural assets become subject to the levy. It is estimated that this concession will cost the Treasury a further £130 million.
However, the greatest risk to government finances comes from migration. Revised forecasts suggest that net migration could fall short of forecasts published by the Office for Budget Responsibility by up to 100,000 people per year. Bloomberg estimates that this would reduce tax revenues by around £9 billion in 2029-30 alone, reflecting the fact that economically active migrants tend to pay more in taxes than they use on public services.
Additional pressure could come from defense spending. Prime Minister Keir Starmer has promised to increase military spending to 2.5 percent of GDP by 2027 and to 3 percent in the next parliament. However, analysis reported by The Times suggests there is a £28bn funding gap over the next four years to meet this commitment, equivalent to around £7bn a year.
Despite these challenges, financial markets have remained relatively calm so far. UK government bond yields have fallen faster than those of comparable economies in recent months, reflecting investor confidence in the Chancellor’s initial fiscal stance.
The question now is whether that confidence will hold if further concessions are made, or whether weaker migration and higher spending commitments will continue to erode the room for maneuver that Reeves has fought hard for.
