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Rachel Reeves’ plans to stabilise the UK public finances and reboot her growth strategy have been upended as the energy crisis shakes the markets and raises the spectre of recession, investors have warned.
The chancellor started the year with a “stability” mantra, vowing to cut the cost of living as she counted on falling inflation and interest rates and signs of a pick-up in corporate sentiment to buoy growth.
Instead, the war in Iran has radically shifted the UK’s economic outlook, economists said. This has derailed Labour’s hopes of being able to claim it is boosting growth ahead of critical local elections in May and prompted warnings of rate rises from the Bank of England.
Treasury officials talk of a darkening mood at One Horse Guards Road as they contemplate what one called “a very difficult Budget” later in the year.
Reeves, who has already raised taxes by £66bn since the last general election, could have to raise them again if she is forced into a costly support package for households and businesses facing soaring energy bills.
“The risk of recession has significantly increased at this point,” said Luke Bartholomew, deputy chief economist at investment firm Aberdeen. Higher borrowing costs and rising energy prices will deliver a “double whammy” to an economy already suffering from a weaker labour market and fragile public finances.
Consumers were already facing a squeeze in 2026, with wage growth slowing and more of their income going towards tax. Now many households could see their wages fall in real terms, as inflation rises well above 3 per cent later in the year, with prices for essentials such as food and fuel once again likely to increase steeply.
Meanwhile the share of British adults who think it is difficult to find work has risen to a post-pandemic high of 62 per cent, according to YouGov polling released on Friday, with the figure rising as high as 79 per cent among 18- to 24-year-olds.
“It is difficult to feel optimistic about the macro outlook right now,” Bartholomew said.
UK government debt prices plunged on Thursday and Friday as investors digested the twin prospects of BoE rate rises and a further weakening in the health of the public finances.
Reports of senior Labour figures including Lisa Nandy, culture secretary, calling for a weakening of the fiscal rules provoked further tremors in the debt markets, with the Treasury swift to insist that this was not on the cards.
“Be in no doubt of this government’s commitment to the fiscal rules,” said one Reeves ally.
Even before the energy crisis there were renewed signs of deterioration in the public finances, with the government borrowing a higher-than-expected £14.3bn in February.
Reeves declared at Davos earlier this year that the UK was well positioned to withstand any new shocks to the public finances without further tax increases.
Asked on Tuesday whether she could repeat that assertion, Reeves insisted the UK was in a “much stronger position” than when Labour took power in July 2024, but she did not directly address whether further tax rises would be needed.
Outside the Treasury, economists say the chancellor’s hope of sticking to her fiscal rules has all but vanished as pressure builds for the government to step in to support households, businesses and public services.
Dan Haile, senior economist at the Institute for Government (IfG), said Reeves would have to “wave goodbye” to the £22bn buffer she had against her fiscal rules.
“That number disappears into the rear-view window,” he said. “Right now, this isn’t a question about fiscal rules, it’s about fiscal strength and sustainability.”
A repeat of the support rolled out in 2022 — which included cuts in fuel duty and substantial subsidies to limit the rise in energy bills for all households — is unlikely this time. Reeves has ordered an internal audit of the Truss government’s energy package to understand how to better target future support.
Options set out this week by the Resolution Foundation think-tank looked at how an annual “budget” of £3.75bn could be focused on poorer households with the greatest need for heating.
“This is not the time for the UK public finances to take a huge unlimited bet on the path of energy markets,” warned Ruth Curtice, chief executive of the Resolution Foundation.
Those on higher incomes could be asked to absorb the shock and do more to cut back energy use by driving less, insulating their homes and installing heat pumps.
But if the crisis deepens, calls for the government to step in on a bigger scale will become hard to resist.
Make UK, the manufacturers’ lobby, describes the situation as “terrifying” for many of its members, even though most are currently protected by fixed-term energy contracts.
It is calling for the government to accelerate a scheme to cut energy costs for manufacturers in key sectors outlined in the UK’s industrial strategy, due to be introduced in 2027, at an annual cost of between £1bn and £3bn, depending on eligibility.
“There are many bits of our economy that are not equipped to pay the price if [energy] goes through the roof and stays there,” Nick Butler, former head of strategy for BP, said at an event hosted by the IfG on Friday, pointing to food producers, hospitals, schools and diesel-reliant railways.
“The government needs to come forward with a plan to manage continuity of supply at a time when there may be both a price pressure and some physical shortage.”
