UK finance minister Reeves trims her spending plans in face of slowing economy

By Andy Bruce, David Milliken and Andrew MacAskill

LONDON (Reuters) - British finance minister Rachel Reeves, facing a weak economy, trimmed her spending plans in a budget update on Wednesday that gave some reassurance to investors, but the risks of a global trade war could put tax hikes back on the table later this year.

Britain's budget watchdog halved its forecast for economic growth in 2025 and said a catch-up towards the end of the decade would not make up all of the difference. It also raised its forecasts for public borrowing and inflation.

Reeves sought to pin the downgrade on "a changing world," citing the war in Ukraine and uncertainty overhanging the world economy which is at risk of upheaval from U.S. President Donald Trump's trade tariff plans.

"The global economy has become more uncertain, bringing insecurity at home as trading patterns become more unstable and borrowing costs rise for many major economies," she said.

However, the budget watchdog said an increase in employers taxes announced by Reeves in her first full budget last October would weigh on growth in earnings for workers from next year, representing another brake on the economy.

Reeves said she would not let the slowdown jeopardise her budget plans and she acted to rebuild a nearly 10 billion-pound ($12.90 billion) fiscal buffer that had been more than wiped out in just five months by the weaker economic outlook and higher borrowing costs.

"These fiscal rules are non-negotiable. They are the embodiment of this government's unwavering commitment to bring stability to our economy," she said in her speech, which focused heavily on increased defence spending.

One of Reeves' self-imposed fiscal rules is to aim to balance day-to-day public spending with tax revenues by 2030. To get back on target, she shaved growth in day-to-day spending on public services to 1.2% a year in real terms from 1.3%.

The centre-left Labour government also announced 4.8 billion pounds of cuts to welfare payments, angering some of its lawmakers.

A government assessment of the changes, which aim to slow a surge in sickness-related benefits, estimated 3.2 million households would lose out and 250,000 additional people would enter relative poverty after housing costs by the end of the decade.

British government bond prices recovered from an initial fall after the government said it planned to issue slightly less debt than expected over the next 12 months.

KICKING THE CAN

"The Chancellor has replenished the fiscal headroom... which may provide some relief in the short term, but this is a temporary fix, kicking the can down the road," said Shamil Gohil, fixed income portfolio manager at Fidelity International.

"Longer term, budgetary challenges remain as higher interest rates and weaker growth persist."

The headroom of 9.9 billion pounds - the margin against which the fiscal rules are met - remains historically low and could be wiped out by any slowing in the economy or a further rise in borrowing costs.

The OBR said measures announced by Reeves would improve the balance of day-to-day spending against revenues by 14 billion pounds in 2029/30.

The OBR highlighted the risk that a U.S.-led trade war could hurt Britain's economy.

If the United States imposed a reciprocal 20 percentage-point increase in tariffs on all its trade partners, Britain's economy would be 1% smaller than its central forecast in the peak year of impact in 2026-27.

Trump is due to announce on April 2 his decision about whether to impose reciprocal tariffs on partners.

The OBR said Britain's government was set to borrow 47.6 billion pounds ($61.4 billion) more by the end of the decade than it expected five months ago.

"If things go badly with the economy and the public finances, then the Chancellor will be back to square one, perhaps with a need to tighten spending again or perhaps tax increases or even a combination of both," Philip Shaw, chief economist at bank Investec, said.

Reeves and Starmer promised voters last year they would not hike income tax or other big revenue-raisers.

But they could extend a freeze on the thresholds at which people start to pay basic and higher rates of income tax - introduced by the previous Conservative government as a way to drag more people into the tax net.  

Liam O'Donnell, a fixed income manager at Artemis Fund Managers in Edinburgh, said investors remained worried about the pace of borrowing in Britain with economic growth so elusive.

"I think the market is going to settle on expecting tax hikes for the autumn," he said.

(Additional reporting by Suban Abdulla, Sarah Young, Sachin Ravikumar, Catarina Demony, Elizabeth Piper, William James, Sam Tabahriti and Noami Rovnick; Writing by William Schomberg; Editing by Catherine Evans, Hugh Lawson, Peter Graff)