Whitehall prepared for spending cuts after Britain was hit by bond market turmoil

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Whitehall departments are expecting tougher spending rules this summer as the Treasury seeks savings after a rise in its borrowing costs.

Officials warned of “really difficult decisions” in the upcoming spending review – with some departments warning it will be difficult to withstand austerity measures given the cuts in recent years.

“We already have to think about how we can achieve what we plan to do with even less effort,” said an interior ministry official. “We are worried.”

The official said full-scale work on the spending review strategy had not yet begun but there was growing concern within the department that the spending bill was being cut.

There are fears that “we need to look at how we spend money more effectively or work with partners to see how we can use our money even better,” they added.

But they added that Downing Street had acknowledged the Home Office had been given a particularly “tough deal” in the autumn budget – with a 3 per cent annual spending cut – raising hopes they would be spared some of the future pain could in the next spending review.

An Education Department official also said rising gilt yields – which reduce the government’s fiscal space – would raise the specter of greater spending restraint in the coming months.

Another adviser said it felt like markets were “testing” the Labor government, adding that the government needed to show it was pressing ahead with cost-cutting plans to reassure investors that it was improving the economy could be entrusted.

“There will be really tough decisions in the spending review in a few months’ time,” the person added.

The unrest followed a rise in British government bond yields that some estimates have wiped out the chancellor’s leeway over the Treasury’s self-imposed fiscal rules.

Isabel Stockton, an economist at the Institute for Fiscal Studies, warned that recent increases in borrowing costs could easily erode most of the “razor-thin margin” over Britain’s fiscal rules if they continue.

The government tried to calm jitters in financial markets on Thursday as Treasury chief secretary Darren Jones insisted it would not breach its budget rules and that investor demand for British government bonds remained healthy.

During Thursday, the 10-year Treasury yield rose as high as 4.93 percent, its highest since 2008, before falling to 4.81 percent. The pound fell as much as 1 percent against the dollar to its lowest level in more than a year.

Higher bond yields would impact the Office for Budget Responsibility’s estimates of the government’s future draft legislation on debt interest payments, which already exceed £100 billion a year. The OBR is expected to publish a forecast on March 26, which will be accompanied by a statement to Parliament from Chancellor Rachel Reeves.

Reeves is expected to meet her key current rule, which bars borrowing for investment, by a narrow margin of £9.9 billion, according to estimates included in the October budget. Analysts now believe that the scope has dwindled due to market movements – even before growth and inflation forecasts have changed.

Jones told the House of Commons that the Treasury was working on its multi-year spending review, due this summer, based on the assumptions set out in the October budget. OBR forecasts would have an impact on discussions with ministers.

Additional reporting by Ian Smith in London