UK Budget Deficit at Three-Year Low But War Headwinds Build

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(Bloomberg) — UK government borrowing dropped to the lowest level in three years, a boost for Chancellor of the Exchequer Rachel Reeves that could be short-lived as the economic fallout from the Iran war spreads. 

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The deficit totaled £132 billion ($178 billion) in the fiscal year through March, a drop of £19.8 billion from 2024-25 and in line with the £132.7 billion forecast by the budget watchdog last month. The gap in March alone was £12.6 billion, the Office for National Statistics said. 

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The figures come ahead of updated plans for UK government bond sales later this morning with economists expecting the Debt Management Office to revise down its gilt remit for the 2026-27 fiscal year. In a positive sign, a cash-based gauge of borrowing in 2025-26 came in £8.8 billion below forecast at £135.9 billion.

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Strong tax revenues brought down the headline deficit after Reeves raised employers’ payroll taxes last April and rapid wage growth combined with frozen thresholds generated billions more in income tax. Capital gains tax also provided a lift.

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The deficit stood at 4.3% of GDP in 2025-26, the lowest since the year before the pandemic. The Office for Budget Responsibility expected it to drop below 2% by the end of the decade when it published updated projections days after the Middle East conflict broke out.

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However, pressures on the public finances are mounting with the war sapping UK growth, pushing up bond yields and increasing demands for higher military spending. Reeves has also announced extra support on energy bills for businesses and hinted at targeted help for low-income households.

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The conflict could wipe out most of her £23.6 billion fiscal buffer under a “severe but plausible” scenario where many of the market moves since the war stick, according to the Resolution Foundation. Its analysis pointed to borrowing being £16 billion higher in 2029-30 when Reeves must meet day-to-day spending with tax revenue under her main fiscal rule.

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A worsening picture in the coming months threatens to reignite speculation over another round of tax rises or spending restraint later in the year. Government debt stood at 93.8% of GDP in March, close to the highest levels since the early 1960s.

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“The OBR’s expectation that borrowing will continue to fall this year will be challenged by the fallout from the conflict in the Middle East,” said Martin Beck, chief economist at WPI Strategy. “For now, however, the implications for the government’s fiscal rules remain limited.”

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The deficit in March was down from £14 billion in the same month last year. Government debt-interest costs fell to £3.2 billion from £4.5 billion a year earlier due to lower payments on inflation-linked bonds. However, the amount collected in fuel duty was the lowest for any month since July 2023, suggesting higher petrol prices prompted drivers to use their cars less.

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Chief Secretary to the Treasury, James Murray said: “Our deficit is down £19.8 billion because of our plan to cut borrowing. In a volatile world the decisions we are taking are the right ones to keep costs down, take back our energy security and cut borrowing and debt.”

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—With assistance from Mark Evans, Joel Rinneby, Harumi Ichikura and Fran Wang.

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