The International Monetary Fund (IMF) has outlined steps the chancellor could take to “refine” her fiscal rules to avoid frequent spending cuts or tax rises.
This could include switching to one annual forecast from the Office for Budget Responsibility (OBR) rather than two, or establishing a “formal process” to allow for “small” breaches in between Budget events.
Under current rules, the government cannot borrow to fund day-to-day spending. Debt also needs to be falling as a share of the economy by 2029/30.
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The problem is that the rules are largely based on forward-looking projections. This means small changes to the economic outlook can erode any “fiscal headroom” the chancellor has, resulting in the need for frequent policy changes.
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For example, Rachel Reeves was left with a £9.9 billion buffer after the Autumn Budget, but this was quickly eroded by high borrowing costs and weak economic growth.
This forced the chancellor to announce unpopular spending cuts less than six months later, slashing the welfare budget in her Spring Statement in March. The Spring Statement was never intended to be a major fiscal event.
Now, a departmental spending review is around two weeks away, and further budget cuts are expected.
The IMF report could give Reeves some leeway to tweak the fiscal rules, with the watchdog's recommendations potentially acting as a shield to public and political backlash.
When MoneyWeek asked the Treasury to comment, they suggested the changes were not currently being considered.
A Treasury spokesperson said: “Our fiscal rules remain non-negotiable as we deliver stability and support growth as part of our Plan for Change.
“We respect the OBR’s independence and role in holding governments to account, which is why the first bill passed by this government included the fiscal lock, preventing the sidelining of the OBR and demonstrating this government will never play fast and loose with public finances.”
IMF upgrades UK economic growth
In the report, the chancellor received some good news in the form of a growth upgrade. The watchdog now expects the UK economy to grow 1.2% in 2025, up from 1.1% previously.
Despite this, the IMF warned that “weak productivity continues to weigh on medium-term growth prospects”.
Responding to the report, Reeves said: “The UK was the fastest-growing economy in the G7 for the first three months of this year and today the IMF has upgraded our growth forecast.
“We’re getting results for working people through our Plan for Change – with three new trade deals protecting jobs, boosting investment and cutting prices; a pay rise for three million workers through the National Living Wage; and wages beating inflation by £1,000 over the past year.”
What are Reeves’s fiscal rules – and what challenges have they created?
Reeves’s fiscal rules have two main components – the stability rule and the investment rule.
The stability rule prohibits the government from borrowing to fund day-to-day spending. This instead needs to be paid for through tax revenues.
The investment rule states that debt needs to be falling as a share of the economy by 2029/30.
While the fiscal rules aim to keep debt under control, Reeves has recently run into challenges thanks to high borrowing costs and weak economic growth.
These have eroded her “fiscal headroom” – otherwise defined as the amount of leeway the government has to either increase spending or cut taxes.
This contributed towards the spending cuts announced in the Spring Statement in March, when Reeves slashed the welfare budget in an effort to save £5 billion a year by the end of the decade.
Reeves didn’t raise any taxes in the Spring Statement, but experts are already predicting further measures later this year when the Autumn Budget comes around.
The latest government figures show that borrowing came to £20.2 billion in April, the first month of the new tax year. This was the fourth-highest level on record for the month, and £1 billion higher than a year ago.
“It’s not the start to the year the chancellor would have wished for,” said Danni Hewson, head of financial analysis at investment platform AJ Bell.
“Despite the impact of her Budget changes to employers’ National Insurance kicking in and boosting Treasury coffers by almost £2 billion, April’s numbers suggest there is still much more to do.”
Hewson points out that inflation-linked benefit increases, pay rises and increasing costs all added pressure to government finances during the month.
Would the IMF’s recommendations ease pressure?
Currently, OBR forecasts are conducted twice a year, but the IMF has suggested reducing this to just once.
This could make sense given Reeves has committed to one Budget per year, carried out in the Autumn. Previous chancellors have often opted for two.
“Having one fiscal event every year but two OBR forecasts simply isn’t politically plausible,” said Laith Khalaf, head of investment analysis at AJ Bell.
“It would require the chancellor to stand up in parliament and state that she isn’t meeting her fiscal rules, but that she’s not going to do anything about it for six months.”
Commenting earlier this year before the IMF report was published, Khalaf also suggested that another option could be to “adjust the fiscal rules to allow for some margin of error at interim forecasts”.
This would mean policy action was only required if there was a “significant deviation from target”.
Without any change to the rules, we could end up in a situation where Reeves is effectively still delivering two fiscal events per year.
While this year’s Spring Statement was more scaled back than a full-blown Budget, it was almost certainly bigger than the government would have liked.
