The article was first published on OMFIF on  Apr 14th 2025.

Peter Sedgwick was a senior UK Treasury official, Vice President of the European Investment Bank from 2000-06, Chair of 3i Infrastructure PLC from 2007-15 and Chair of the Guernsey Financial Stability Committee 2016-19 .

Government borrowing should be for investment

The UK government’s macroeconomic policy was already off track before President Donald Trump’s tariff shocks damaged financial markets, worsened prospects for growth of trade and output and enormously increased uncertainty. It is now highly unlikely that the government’s original aspirations for borrowing, public spending and taxation can all be achieved.

Rather than tying itself in knots vainly trying to demonstrate fulfillment of its manifesto pledges and other earlier commitments, it should view the current crisis as an opportunity to reset macroeconomic policy. This would involve being candid about growth and the poor fiscal prospect over the rest of this parliament while keeping borrowing under control.

Getting borrowing under control

The UK shares low growth and difficult public finances with some other European economies. Rather than indulging in a political blame game over responsibility for low growth and fiscal ‘black holes’, the government should be honest about constraints that low growth causes for fiscal policy and the fact that any benefits of a growth strategy will occur in the next parliament and beyond.

It is essential in the post-Trump turmoil that the government takes no risks with the bond and foreign exchange markets. The dangers are obvious. In the course of 2025, the UK has become the G7 economy with the highest cost of government long-term borrowing, a message from the markets it would be unwise to ignore.

To be best placed to cope with external shocks and to reassure financial markets, the government will need to show that it is prepared to take the necessary decisions to control borrowing. These could include a tight control of public spending but also increases in VAT or income tax. As soon as possible, government borrowing should be solely for investment.

The constraint on public investment will be the willingness of the markets to absorb gilts. In this context, the government should revisit the relationship with the Bank of England to stop its sales of gilts to the market, an unnecessary and damaging process in current circumstances. Gilt sales should be used to refinance maturities and finance investment.

The UK should look outside of itself

The debate about the UK’s low growth of gross domestic product and productivity in recent years has been unnecessarily insular. Currently the underlying growth of productivity is probably lower in Germany than in the UK. In contrast, in the 25 years before the second Trump administration, the US economy with its massive tech sector and world-dominating companies grew significantly more than Europe.

The explanation of and cure for the UK’s low growth is not helped by attributing it largely to the policies of political opponents. Trump’s tariffs and the general uncertainty that they cause could lead to lower UK growth. Depending on the outlook for inflation there may be scope for short-term interest rates being reduced more rapidly and more often.

Where there are crises in individual sectors, the government may come under irresistible pressure to provide financial help, as is already happening in the steel sector. The balance of probability is that the fiscal prospect will be worse than in the spring statement and the government will have to decide how to react.

Reframing fiscal policy

The main constraint on fiscal policy will be the government’s ability to finance its borrowing through gilt sales. Fiscal rules are simply one way by which governments seek to reassure markets that they will act responsibly. Criticism of fiscal rules as being arbitrary and of the role of the Office for Budget Responsibility in showing whether and by how much the rules are likely to be kept is wide of the mark. Without rules it would probably be even more difficult to convince markets of the soundness of government finances.

Any significant rise in projected government borrowing, even if it were all for investment, would be a huge risk at a time when UK borrowing rates are the highest in the G7 and higher than in most European Union economies, including Greece (Figure 1). At first sight it is puzzling that economies like France and Italy, which have larger debt burdens than the UK, have lower long-term interest rates. It may be that lower EU borrowing rates reflect a market expectation that in a crisis the European Central Bank would find ways of purchasing member states’ debt.

The Bank of England is currently engaged in unnecessary monetary tightening. The Bank selling gilts in the market is a monetary policy operation, but it directly impinges on the operation of fiscal policy and should be subject to the same decision-making processes that govern fiscal policy. This is particularly the case at a time when the UK has high long-term borrowing costs by international standards. It would be unwise in the extreme to ignore the message from the markets.

Against this economic and market background, the government should reframe fiscal policy. It should move quickly to a position where borrowing is solely to finance investment by reducing the current deficit. In addition, it should vigorously pursue ways to finance investment other than through the bond market. One obvious way to do this is through a revitalised private finance initiative for large infrastructure projects. There are signs that this is happening, such as the Lower Thames Crossing.

The scope for controlling fiscal policy in a low-growth economy solely by cuts in spending plans will be limited, particularly if the government feels obliged to help sectors damaged by the tariff crisis or to provide relief to those parts of the private sector badly affected by the simultaneous higher employers’ national insurance charges, an increased minimum wage and the forthcoming employment legislation.

The firm intention should be that the departmental spending plans for the later years of this parliament – which are unhelpfully due to be published in June rather than with the spring statement or the autumn budget – should not be liable to substantial revision in the autumn fiscal event if lower growth causes forecast borrowing to be higher than the fiscal rules allow. A less damaging response would be a broadly based increase in income tax or VAT.