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City economist are warning tha the UK borrowing is set to be driven higher by the Iran war, following this morning’s (small) drop in UK borrowing in the last financial year:
Lindsay James, investment strategist at Quilter, says:
“The conflict in the Middle East has shown the UK economy remains very exposed to geopolitical shocks. However, there are some encouraging signs that rigid fiscal rules have been having the desired effect thus far, as today’s public sector finance data shows borrowing was £12.6 billion in March. This is £1.4 billion less than the same month last year, and the lowest March reading since 2022.
“Borrowing had been expected to be lower this year as the government had front loaded a lot of its spending plans into its early years, but things could get more difficult from here on out. With inflation on the rise, debt interest climbing again and gilt yields also becoming elevated once more, the fiscal headroom Chancellor Rachel Reeves had established could very quickly run out once again. As such, tax is likely to feature prominently as the lever to pull to help keep the public finances on steady ground, and we have already seen the burden this places on growth.
March’s figures showed an unexpected undershoot of the OBR’s forecast for public borrowing in 2025/26. But we do not expect this improvement to last long. We think the energy price shock will mean that borrowing overshoots the OBR’s forecast by a huge £29bn for the 2026/27 fiscal year and by about £13bn in subsequent years.
“The good news for the Chancellor is that full year borrowing for 2025/26 came in at £132.bn, down from £151.9bn in the previous financial year, and in line with the latest OBR forecast. The bad news is that the war in Iran means the situation will deteriorate sharply over the rest of this year. That will limit her ability to offer households and businesses a significant bailout if energy prices move higher.
“Looking ahead, March will probably be the last month of good news on borrowing. Gilt yields are down from their 5% peak in March, but are still significantly higher than before the war. Borrowing costs will rise quickly from here though, as higher interest payments on index-linked gilts weaken the near-term fiscal position. At the same time, the economy will almost certainly slow, which could send the unemployment rate trending back up. That would lower income tax receipts and raise welfare spending.
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