Burnham’s funding gap: what state are UK finances in for the PM-in-waiting?

An economy rattled by a global energy shock, jittery bond markets and rising spending demands. As Andy Burnham prepares for government, the pressures on the public finances are in focus.The prospective prime minister pledged a new direction for Britain this week within two constraints: sticking to Labour’s current fiscal rules, and consistency with its 2024 manifesto.Even before his expected arrival in Downing Street, Burnham will have a tough starting position.In committing to the fiscal rules drawn up by Rachel Reeves, the most recent reference point for how much wiggle room Burnham could have as prime minister was spelled out in the chancellor’s spring statement in March.Reeves left herself £23.6bn of “headroom” against the primary requirement of her fiscal rules to balance day-to-day spending with receipts within five years’ time.Since then, however, the impact of the Iran war on the UK economy, rising government borrowing costs and Keir Starmer’s defence investment plan are likely to have eaten into some of that buffer.As he prepares to leave office, the outgoing prime minister announced £15bn in additional defence spending over four years this week, but did not give full details on how it would be funded.According to the Treasury, £10.3bn will be raised by “reallocating budget” from across government departments. Many of the decisions on how these budgets would change have yet to be made, however, leaving the new prime minister a headache. Another £4.7bn will also need to be found in the autumn budget, a shortfall of about £1.2bn a year.Still, the extra spending could be covered without blowing the fiscal rules.Judging this will be down to the Office for Budget Responsibility (OBR), which will need to take into account a wide range of headwinds and tailwinds for the public finances far beyond the extra costs from Starmer’s defence investment plan.skip past newsletter promotionafter newsletter promotionForemost is the impact from the Iran war, which has driven up inflation and is weighing on economic growth. In a reflection of this economic shift – and as the England" class="entity-link entity-organization" data-entity-id="2477" data-entity-type="organization">Bank of England keeps interest rates on hold – the government’s borrowing costs have increased, adding to the bill for servicing Britain’s £2.9tn national debt.According to the Financial Times, however, the Treasury is expected to tell Burnham within days that the war has done less damage than first feared, inflicting only a modest hit to the headroom left by Reeves.It reported that Capital Economics had estimated as recently as May that the war could erase £10bn from the chancellor’s £23.6bn of headroom, but it now anticipates little change in the OBR assessment after a fall in global oil prices and bond yields since the height of the Middle East crisis.How much leeway Burnham has will depend partly on how the England" class="entity-link entity-organization" data-entity-id="2477" data-entity-type="organization">Bank of England responds. It will also depend on whether the premier-in-waiting can avoid provoking a negative bond market reaction. City investors will be watching his pick for chancellor closely.So far, Burnham’s commitment to stick to the fiscal rules has kept the bond markets quiet. Yields moved little after his scene-setting speech on Monday.The government will, however, still face the challenge of funding any additional spending on emergency energy support, as well as any new policies Burnham wants to pursue. In that context, analysts at the Swiss bank UBS say a key question will be whether he may need to look at tax increases at the autumn budget.