Labour must reduce welfare spending and borrowing or risk a backlash from financial markets as Britain's borrowing costs continue to climb.
The International Monetary Fund (IMF) has warned in its annual assessment of the UK economy that ministers must "stay the course on deficit reduction" to prevent further pressure on public finances.
The IMF said there was only "limited" scope for additional tax rises following Chancellor Rachel Reeves's £75billion of tax increases since taking office less than two years ago.
With the tax burden now sitting at its highest level since the Second World War, the Fund warned that "difficult choices to contain spending" would become unavoidable.
The IMF upgraded its UK growth forecast to one per cent for 2026, up from the 0.8 per cent prediction issued last month.
The revision followed official figures showing the economy expanded by 0.6 per cent during the first quarter of 2026, marking the strongest quarterly growth in a year.
However, the IMF said the conflict in the Middle East was now "dampening near-term prospects" for the British economy.
Luc Eyraud, the IMF's mission chief to the UK, said the improved growth outlook "reflects stronger carryover and pre-shock momentum not a re-evaluation of the headwinds now coming from the Middle East war".
The Fund also forecast inflation would rise to just under four per cent by the end of 2026 as energy prices continue increasing, leaving inflation almost double the Bank of England's target.
IMF warns Labour to slash welfare spending and borrowing or risk market backlash
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Government borrowing costs climbed sharply following publication of the report, with yields on 30-year gilts reaching 5.86 per cent for the first time since 1998 before easing slightly later in the session.
The 10-year gilt yield also rose close to 5.2 per cent, a level not seen since 2008.
Markets have been unsettled by rising oil prices linked to the conflict involving Iran alongside political uncertainty within Government.
Kemi Badenoch previously warned Britain could face a "Burnham premium" if Andy Burnham were to succeed Keir Starmer as Prime Minister.
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IMF warns Labour over welfare spending and borrowing as UK gilt yields hit multi-decade highs
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Critics have argued Mr Burnham's approach could lead to higher borrowing and increased national debt.
The IMF also appeared to caution Labour MPs calling for a more Left-wing economic agenda.
The report suggested future spending reforms could include changes to the state pension triple lock and "expanding charges in the health system".
Looking ahead, the Fund warned Britain would face mounting financial pressures over the next 20 years from an ageing population, defence spending commitments and climate transition policies.
The IMF report stated: "Beyond the planned tax ratio increase until 2030, staff analysis suggests that the long-term scope for further revenue increases is becoming limited unless more fundamental tax reforms are envisaged."
The Fund also advised any support for households facing higher energy bills should remain "targeted, temporary, and financed through offsetting measures".
Interest rates are expected to remain at 3.75 per cent for the rest of 2026 under current energy market assumptions, although some economists believe further increases may be required to tackle inflation.
Ms Reeves welcomed the IMF's assessment and said: "The IMF upgrading its growth forecasts and backing our fiscal strategy is yet more proof that this Government has the right economic plan."
She added: "The choices I have made as Chancellor mean our economy is in a stronger position as we deal with the costs of the war in Iran."
"Putting our stability at risk when signs of progress are emerging would leave families and businesses worse off," Ms Reeves said.
Susannah Streeter, chief investment strategist at Wealth Club, said: "Gilt investors are the canaries in Labour's coalmine, demonstrating the increased wariness with which the UK is being viewed."
Ms Streeter warned political uncertainty was adding to global tensions at a time when Britain needed stability to attract investment.
Recent selling pressure in the gilt market has pushed borrowing costs higher, increasing strain on public finances as some Labour figures continue calling for higher spending.