Little relief for the Chancellor as borrowing remains stubbornly high
Martin Beck, Chief Economist | Economic Consulting and Analysis
UK government borrowing was in line with expectations in September and the deficit in the year to date was revised down, but the Chancellor’s fiscal challenges are far from over.
Borrowing in line with expectations, but little room for comfort
Although borrowing in September broadly matched the Office for Budget Responsibility’s (OBR) forecast, the picture remains worrying. A deficit of £20.2 was virtually identical to the OBR’s March projection of £20.1bn, but still marked the largest September shortfall since 2020.
While the ONS revised down cumulative borrowing this fiscal year by £4.2bn, it remains high at £99.8bn - above the OBR’s £92.6bn projection (Figure 1). Meanwhile, the current budget deficit, which is key to the government’s fiscal rule, reached £71.8bn in the first half of 2025–26, compared with the OBR’s forecast of £58.8bn.
Figure 1: Public borrowing has continued to outstrip the OBR’s forecast so far this year
As things stand, total borrowing this year could overshoot the OBR’s full-year forecast by around £10bn, pushing the deficit close to 5% of GDP, uncomfortably high for an economy operating near full employment and well beyond the pandemic and energy-crisis shocks. Still, the public sector’s sizeable deficit is partly a mirror image of the large financial surplus being run by households, and therefore not wholly within the government’s control.
Some reasons for optimism
There are, moreover, a few offsets. Recent revisions by the ONS to historical GDP numbers mean the economy is now estimated to be over 2% larger in cash terms than the OBR assumed in March, meaning a stronger base for tax receipts. Inflation and pay growth have also exceeded the OBR’s expectations, which should boost forecast VAT, income tax and National Insurance revenues.
At the same time, gilt yields eased over the last week, helped by falling US interest rate expectations, which could reduce debt interest costs if sustained.
A fiscal hole still to fill
But the OBR’s timetable for its Budget forecast means the recent fall in gilt yields may have come too late to shrink the estimated fiscal “black hole”. And even allowing for some positives, the Chancellor still faces difficult choices. Higher spending commitments, borrowing costs that remain above the OBR’s March assumptions, and a likely downgrade to medium-term productivity forecasts all point to a widening fiscal gap.
We estimate the Chancellor may need to tighten policy by around £20bn simply to restore the fiscal headroom she pencilled in in March. In practice, she may choose to go further, both to finance targeted “giveaways” such as a cut in VAT on fuel, and to rebuild fiscal resilience.
That tax increases will shoulder the burden of repairing the public finances now looks inevitable. Given the scale of the fiscal gap, and the political obstacles the government faces in restraining public spending or driving stronger economic growth and tax revenues through structural reform, Rachel Reeves may ultimately have little choice but to raise one or more of the “big three” taxes - income tax, National Insurance and VAT.
What it means for business
For businesses, the fiscal backdrop points to a challenging policy environment.
Tax risk remains high. With the tax burden already heading for a post-war peak, additional rises could further squeeze disposable incomes and corporate margins.
Public spending restraint. Although the bulk of any fiscal tightening is likely to happen through tax hikes, some departments could face tighter budgets, potentially limiting government demand and slowing infrastructure or procurement pipelines.
Confidence and investment. Higher taxes or prolonged fiscal uncertainty could weigh on confidence, hiring, and capital spending decisions.
In the near term, businesses should expect fiscal policy to remain a drag on growth, even as interest rates fall further.
Our take
The latest figures do little to dispel the view that the Chancellor’s fiscal headroom has disappeared. While a bigger-than-expected cash economy and firmer tax receipts offer some cushion, these are being outweighed by spending pressures, policy reversals, and the likelihood of weaker productivity assumptions.
Repairing the public finances will almost certainly involve politically difficult tax decisions. Yet the longer-term risk is that ever-higher taxes erode incentives, competitiveness, and the investment needed to lift productivity - the ultimate foundation of a sustainable fiscal position.