A dramatic slowdown in economic growth and rising borrowing costs since the budget could undermine the government’s finances and force the chancellor, Rachel Reeves, to U-turn on pledges not to further increase taxes, analysts have said.

With inflation on the rise again, the London stock market at its lowest point for more than a month and the Bank of England forecasting economic stagnation in the final three months of 2024, the government heads into the Christmas break weighed down by a gloomy outlook for the new year.

The prospect of a trade war with the US after Donald Trump is inaugurated in January has also weighed on markets. In statements on social media on Friday, the president-elect threatened the EU with tariffs on exports to the US, which could be extended to include the UK.

City economists said the rise in inflation over the past three months would force the Bank to maintain high interest rates, which would weigh on household spending and dent Reeves’s plans to grow the economy.

Without the growth promised in the budget, the chancellor could be hit by lower tax receipts and higher borrowing costs.

The EY Item Club said more than half the chancellor’s spare funds during this parliament could be wiped out by interest rates remaining higher than expected next year.

Bank officials kept rates at 4.75% on Thursday after saying inflation remained too high. It added that pay growth was strong enough to potentially send inflation even higher over the next year. Companies have blamed the Reeves’s autumn budget for sapping consumer confidence and hitting demand for new staff while the Bank said it had added to “additional uncertainties around the economic outlook”.

Inflation increased to 2.6% in November, up from 1.7% in September, while wage growth rose to 5.2%, according to official figures.

Financial markets judged that the central bank would hold back on interest rate cuts previously considered to be certain in 2025. Only two quarter-point cuts are now expected next year, which would bring interest rates down to 4.25%.

Long-term UK government borrowing costs are now higher than during the market panic after the mini-budget in 2022 due to a sell-off in UK gilts since September. On Thursday, the yield – or interest rate – on 30-year government bonds approached a 26-year high of more than 5.15%, according to Bloomberg data.

This week, the yield on benchmark 10-year British gilts hit its highest since November 2023, at 4.65%, up from 3.75% in September, in another sign that the cost of issuing new debt has risen.

In London, the FTSE 100 fell by 1% to its lowest level in five weeks during Friday trading, and recorded its biggest weekly fall since October last year.

The index of leading companies, which hit a record high of 8,474 points in May this year, has lost 3% of its value during December as investors fret that economic growth is flatlining while inflation is picking up.The Office for Budget Responsibility (OBR), the Treasury’s independent economic forecaster, has predicted government borrowing will be almost £130bn in this financial year, leaving Reeves with about £10bn of headroom to meet her fiscal rule of reducing the annual deficit to almost zero by 2030.

Matt Swannell, the chief economic adviser to the EY Item Club, said figures showed the health of the public finances in November were better than expected, but still left the government on course to lose more than half the headroom to maintain its public spending plans.

UK borrowing last month was £11.2bn, which was the lowest November figure for three years.

“Reeves has said there will be no policy changes alongside the forecast update,” Swannell said. “But even if the OBR continues to judge that policy complies with the fiscal rules at that point, it’s likely to be a problem deferred, not resolved.”

He added that navigating the review of Whitehall spending, which us due to take place next summer, will be challenging without extra income from higher taxes.

Rob Wood, the chief UK economist at Pantheon Macroeconomics, said inflation was on course to continue rising to 3.1%, prompting the Bank of England to keep interest rates higher than expected for a longer period.

Much of the government’s debt is held by the Bank and in index-linked bonds that track the retail prices index (RPI). High central bank interest rates and rising inflation will scupper calculations by the OBR that the government’s borrowing bill will tumble over the next five years, allowing for higher spending on welfare and public services.