July tax windfall offers brief respite, but the fiscal squeeze is far from over

The latest public sector finance figures offer the new Government some welcome relief – but one encouraging month will not be enough to prevent difficult decisions that must be made in the upcoming October Budget.

Public Sector Net Borrowing, excluding public sector banks, was recorded at only £1.8 billion in July, a dramatic improvement on the £16 billion borrowed in June.

However, July is traditionally a strong month for public finances, helped by substantial self-assessed income tax receipts. And so, this improvement must be treated with caution.

The bigger fiscal picture remains uncomfortable. Borrowing during the opening months of this financial year has been running above the OBR’s forecasts, while Government debt-to-GDP is still stubbornly high at over 94%. High debt-interest costs, now forecast at over £115bn for the fiscal year, and continued pressure on public services further restrict the Government’s room for manoeuvre.

This state of affairs makes the Autumn Budget increasingly important. July’s improvement in the public finances will not continue throughout August and September, meaning the new Government will be forced to engineer a significant fiscal squeeze in their first Budget.

The choices are unlikely to be easy. The Chancellor will have to find some combination of additional tax revenue, tighter control over public sector spending and changes elsewhere in the Government’s economic plans to balance the books and to meet the fiscal rules introduced by Rachel Reeves. Failure to do so will unsettle the financial markets and potentially push up the cost of government borrowing still further. Yet pushing taxes significantly higher would weaken consumer and business confidence at precisely the point when the economy needs stronger investment and growth.

July’s reduced borrowing helps, but does not make the difficult choices awaiting the government in October disappear. A difficult balancing act remains: maintaining financial credibility with financial markets while avoiding policies that unnecessarily weaken the economy.