Weekly update – fiscal holes, bond markets and child poverty analysis

In the wake of the election results, attention is now turning to the possible policy programme of the new Scottish Government. Over the next few weeks, the First Minister will be elected, the Cabinet appointed, junior Ministers given jobs, and the Committees in the parliament set up to scrutinise legislation and conduct inquiries. Committee conveners will be elected by the members, a new initiative for the seventh session of Holyrood. It is likely therefore that we will be well into June before the shape of the new parliament has settled down.

The mood music seems to be that the Scottish Government will seek to govern as a minority government, which means they are likely to work with individual parties on individual issues. A John Swinney-led administration has a track record of doing this in the last session, making deals with both the Lib Dems and Greens to pass budgets (even when he didn’t have to, as Labour has made it clear they would abstain). The new SNP minority government may try to publish something before recess to set out the priorities for this session, but we would expect that a full programme for government to come as parliament returns in the first week of September.

All through our coverage of the election, we have been raising the elephant in the room: the extremely tight fiscal conditions that the new government will have to contend with. Increasing social security spending, greater demand for services, and (most importantly) public sector pay deals that have outstripped the government’s own pay policy are all putting pressure in the budget in 2026-27 and 2027-28 and beyond. The first budget that the new finance secretary is going to have to put before parliament in (probably) December for 2027-28 is likely to be one of the most challenging since devolution.

Will there be a £5bn black hole in the budget by 2029-30?

We have been asked this question a number of times, both as part of the election coverage and since. This figure comes from the Scottish Government’s Medium Term Financial Strategy which was published in June 2025. See our blog at the time for a discussion about this.

The £5bn figure, though, is the answer to a particular question. This is a simplified version, but broadly, the Government asked:

• If Health spending keeps increasing at the rate it has over the last few years (at roughly 4% in real terms each year); and
• If social care speeding increases at the same rate; and
• If all the pay deals that aren’t yet settled meet the government’s pay policy; and
• Social security spending increases in line with the Scottish Fiscal Commission’s forecasts; and
• If no other area of spending is cut in real terms (so grows in line with inflation);
• Then – how much will that cost; and
• How different is that to the resources we are likely to have available to us?

The answer to this question is £5bn by 2029-30. We’ve set out here the thinking behind to gap on the resource side, as we’re not sure exactly how they came up with the capital gap which is included in the figure. But you can see that the figures in the MTFS were not setting real plans for the medium term, as it did not set out the choices that would be made to (e.g.) cut some departments in real terms to ensure that others could continue to take up an increasing share of the budget (such and health and social security).

That’s why we have often questioned the value of concocting these figures in this way for the MTFS, instead of setting out actual medium-term spending plans. It doesn’t actually provide a sense of where the government are taking the hard decisions.

Fiscal reality did have to bite in the budget, presented by the Scottish Government in January. That showed, for example, that Health Spending will grow by 0.7% in real terms into 2026-27. And, in the 3-year spending review published alongside the budget, they set out portfolio allocations for the next three years – which showed that Health will increase by 6% over three years, and that local government, justice and higher education will be cut in real terms over the period.

Alongside this, the government set out efficiency savings and workforce reductions which will help them meet these more fiscally constrained outlook for portfolios. And whether, if these cuts happen in reality, it can happen without actually reducing services delivered to the public. Local government, justice and higher education have all had tight settlements across the last parliament, and some of the assumptions about efficiencies are yet to be tested.

One thing that was not addressed in the Budget or the Spending Review, though, was the fact that public sector pay deals have continued to completely outpace the policy of the Scottish Government. These deals are not just a cost in 1 year: they permanently increase the pay bill, and consolidate into future years. While some of the plans of the government include reductions in the public sector workforce, there is not yet a credible workforce plan (including strategically where reductions should fall to protect priority areas), and an assessment of where more reductions are required given the higher than expected pay deals.

So, does the government have a £5bn hole in its budget? No.

However, it does have an unknowable (to us anyway) gap between what they said was affordable on pay and what has happened in practice. They also are likely to face pressures in (e.g.) health and social care, which may mean spending on those areas needs to be upped at the further expense of non-priority areas. So, over the Summer, we’ll be watching closely for what is said on pay deals and workforce planning to see if the government are getting a grip of this before the 2027-28 budget, which would be challenging without this additional pressure. We also can’t rule out that an in-year fiscal event will be required to control spending during 2026-27.

So – there’s a huge fiscal issue, and action will be required to deliver a balanced budget for 2027-28.

Bond markets reacting to chaos at Westminster

As we write, there is much speculation regarding the leadership of the UK Labour Party, and what that mean for the UK Government’s direction going forward. And one area that’s garnered particular attention has been where fiscal policy might go.

By and large, reports throughout the current Parliament have been of both backbenchers and ministers being frustrated by the fiscal rules which currently operate. As a reminder, these are for the current budget (that is, excluding investment spending) to be in balance by 2029-30 and in the third year of the forecast thereafter, and for net financial liabilities (a broader measure than public sector net debt) to be falling as a share of GDP at that same horizon. These are already quite a bit looser than what Chancellor Rachel Reeves inherited back in 2024, and are only just about being met.

One of the main potential candidates for Labour leader, Andy Burnham, made headlines last year for criticising Britain being “in hock to the bond markets” and called recently for defence spending boosts to be ‘excluded’ from the fiscal rules. In a similar vein, a paper published earlier in the week by former Transport Secretary Louise Haigh made the case for a longer, 10-year window for the fiscal rules to bind.

The gilt market has today been reacting very badly, with the consensus being that this is driven by the increased likelihood of a new Prime Minister who will want to borrow more than the current plans – possibly significantly more. Yields are up significantly across all horizons, and nearly 0.2 percentage points for the 10-year benchmark. The yield on the long-term, 30-year gilt is now inching towards 6%.

There has been much criticism of ‘bond vigilantes’ and the constraints they put on government policy. And they do constrain it, of course. But it’s worth moving past this argument and asking why that might be the case.

Bond investors don’t really care about the level of spending and taxation, but about borrowing – the difference between the two. In that sense, the constraint they pose and their reaction is related to the balance between the government’s decisions on both sides of the ledger, not a particular set of ideas about what tax and spending should be independently.

The UK’s borrowing position might not be one of imminent crisis, but it’s far from a comfortable one. Net borrowing is projected to have been around 4.3% of GDP in 2025-26 – the lowest since the pandemic, but still very high relative to what is sustainable in the long run. But even with the significant reduction in borrowing pencilled into the OBR’s forecasts – one which many expect to be politically difficult to deliver – net debt would barely be falling at the end of the decade, when it would be 96% of GDP and 2 percentage points higher than today.

The reality is that since 2017-18, public spending has been on steep upward trajectory. It’s now a full 5 percentage points of GDP higher, whereas receipts are a mere 3.4 percentage points higher. We have been running quite loose fiscal policy for near-enough a decade.

In an ideal world, bond markets wouldn’t dictate every move a government makes. But when you’re relying so heavily on other people’s money to finance your fiscal policy, you give up the privilege of setting the terms. In some sense, we are already exploiting some leeway by being able to postpone adjustment a few years into the future. Insisting on lengthening the term of adjustment, for example, is a luxury that is unlikely to be afforded to the UK on favourable terms. So is ignoring some borrowing just because it serves a particular purpose.

As the old joke goes, we wouldn’t start from here if we had a choice. But we don’t – defaulting is an even worse course of action, and so we must face reality, however unpleasant or far away from ideal it may be.

Update on child poverty stats

Scottish Government has put out supplementary statistics to accompany the main poverty publication from March. These include statistics on poverty rates among priority family groups and on work, housing, and food security/affordability in low-income households with children.

What do the data show? As we discussed when the main statistics came out, developments in poverty data mean that we can’t compare poverty rates after 2021-22 with those from before.

That said, between 2021-24 and 2022-25, relative child poverty rose for 4 of the 6 priority groups – only children in households with a disabled person saw an improvement.

	Relative poverty rate (after housing costs)
Group: Children in…	2021-24	2022-25
All households	22%	21%
Any priority group	27%	26%
None of the priority groups	7%	5%
Households with a child under one	35%	39%
Households with a disabled person	25%	23%
Ethnic minority households	38%	40%
Lone parent households	29%	30%
Large families	36%	38%

* The estimates for children in households with a mother under 25 were deemed unreliable due to a small sample size and were not published.

But, as we saw in March, child poverty generally fell slightly over the same period – and it also fell for children who fall into any of the priority groups. If that’s confusing, it’s because, among the priority groups, the largest group is children in households with a disabled person – so the fall in that group’s poverty rate offsets the rise in other (smaller) groups’ poverty rates.

A mixed picture overall, but one in which poverty rates remain stubbornly high for children in the priority groups. To put this into perspective, only 5% of children were living in poverty in 2022-25 when they didn’t fall into any of these groups – down from 7% in 2021-24.

Finally, there were additional statistics on work, housing, and food in low-income households with children, defined as those in the poorest 30% of households. These are particularly helpful for understanding some of the pressures on low-income families’ finances.

Among low-income households with children, median hours worked didn’t change from 2021-24 to 2022-25, and average hourly pay rose by about 2% in real terms (modest, but comparable to growth in real pay in the UK post-pandemic).

On the costs side of things, housing costs rose as a percentage of net household income (from 16 to 18%), while food expenditure fell (from 17 to 16%). The rate of low or very low food security also rose from 24 to 25%.

The detail in these additional statistics is set against a backdrop where in-work poverty has risen, but also where work status is still one of the strongest predictors of poverty. In the latest period, 18% of children in Scotland were living in relative poverty when at least one person in the household was in work – and only 7% when all adults were working full-time – compared to 48% when nobody was in work. At the same time, three-quarters of children in poverty were in working households, compared to less than half before the early 2000s.

These are signs that employment policy could make a difference to child poverty rates – but campaigners will be familiar with the barriers to work faced by many priority families, many of which are not easily overcome by standard employability services. And the effects of the cost-of-living crisis continue to be felt – particularly by households  with the lowest incomes.

All in all, lots of detail for those with an interest in specific groups – and some welcome additions to the usual statistics.