4 July 2025 - 4:30pm
The important question to ask about Britain after seeing Chancellor Rachel Reeves crying at Prime Minister’s Questions this week is not “who will eventually replace her?” One need not even ask whether Keir Starmer is going to survive. The question that truly must be asked is whether or not the country is solvent.
Solvency is a long-term concept — an ability to service your debt in the long-term while maintaining a high degree of monetary stability. The answer seems to be no. Bond markets have sovereign debt as a unique category, because sovereign debtors have the right to raise taxes and issue debt. This is why EU debt is not sovereign but sub-sovereign, much to the annoyance of Brussels. But it is far from clear whether the UK government is in a position to exercise its fiscal sovereignty.
If a government with a majority as large as Labour’s cannot cut social spending or raise taxes, then what exactly is the nature of its sovereignty? Like other Nato leaders in Europe, Keir Starmer has just committed himself to the alliance’s 5% spending target by 2035, with no idea of how to finance it other than through borrowing.
In both France and the UK, the price of servicing debt is enormous. The UK’s Office for Budget Responsibility wrote in a report this week that it underestimated five-year borrowing costs, which will now amount to 3.1% of GDP — a cool £100 billion.
Paul Johnson, the director of the Institute for Fiscal Studies, was brutal in his latest assessment in the Times. “Debt is close to 100 per cent of national income, and it is not falling. Borrowing last year was over £150 billion. Spending on debt interest is well over £100 billion a year,” he wrote. “We can argue about the details of the fiscal rules, but the idea that we can simply borrow more to cover growing pension and benefit bills, and the promised £30 billion a year extra on defence spending, and to increase spending on health and all the rest, is for the birds.”
Labour will end up raising taxes, but this won’t solve the problem. A rise in further borrowing would be irresponsible and not tolerated by the bond market. The rise in gilt yields on Wednesday is a clear sign that the markets are now expecting another more Left-leaning chancellor than Reeves. Johnson, for his part, predicts a brutal budget in the autumn, with big tax rises. Given that Labour has no idea how to make structural savings in the economy, a rise in taxes is the only political choice available.
But it won’t work. Raising the money in the form of tax will slow down the economy and further change debt dynamics. Despite Brexit, the UK is now very European in terms of its tax rates and growth dynamics. It got rid of expat taxation and corporate taxes are at 25%, a rate that Germany will soon match. Income taxes are in the same ballpark.
European countries can either afford to raise defence spending, or maintain the current welfare provision, but they cannot do both and remain solvent. Since there is no widespread political desire for further welfare cuts, and since it seems increasingly harder to convince the electorate about defence spending, Labour could be facing a big solvency crisis in the coming years. The bond market’s behaviour certainly suggests as much.
This is an edited version of an article first published in the Eurointelligence newsletter.
