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Few can still doubt that the UK economy is on the cusp of a deep and nasty slowdown. Indeed, the recent financial sector turmoil appears to have affected investor and consumer confidence to such an extent we may not see any meaningful recovery in economic growth before 2010 at the earliest. This has been recognised by both the Bank of England and the government and, as such, the markets anticipate further aggressive rate cuts and fiscal stimuli.

The idea of extra spending on public works in times of distress is classic Keynesian economics and makes sense to an interventionist government. Gordon Brown will see little wrong in using the public purse to boost employment and support certain ailing sectors of the economy, such as the building industry, by fast-tracking medium-term investment plans. The hope is that spending in selected key areas will provide a backbone to other more vulnerable sectors.

Unfortunately, there is a cost. In purely numerical terms - when considered on top of the pledges to recapitalise the banking sector, the compensation package relating to the abolition of the 10 per cent income tax band and the 2.5 per cent public sector pay settlements - total government spending suddenly looks very large. This would matter less except for the fact tax revenues look set to fall sharply as the economy weakens. The end result is a further black hole in government finances, requiring yet more borrowing via the gilt market.

At the 2008 Budget presentation in March, chancellor Alistair Darling forecast gross gilt sales of £80bn for this financial year. We are now looking at a number closer to £120bn-£140bn, a significant increase. More worryingly, this high level of issuance is likely to persist for a number of years. While these are clearly exceptional times that demand an immediate strong policy response, the concern of many investors is that this merely represents the continuance of a longer trend. UK government borrowing has been rising sharply for many years, and the fear is that a decade of overspending and reckless financial mismanagement has left borrowing on a steep upward path and changed the landscape of the gilt market.

Of course, this would not be worrying were it not for the fact all borrowing must eventually be repaid. The larger the debt, the heavier the burden on tomorrow’s taxpayers – if only in interest payments alone. Mr Darling has promised that spending will be cut back when the good times return, but recent experience provides little comfort. If the gilt market has any semblance of doubt that public finances are not sound, the reaction will be severe. There are already rumblings over the independence of the Bank of England being stripped away.

This raises the question: who will invest in these bonds? The obvious candidates are the pension funds. Of the mainstream asset classes, it is now widely accepted that gilts (both conventional and inflation-protected) offer the closest, low-risk match for defined benefit pension-scheme liabilities. These funds have been big buyers in recent years as, prompted by changes in the regulatory and accounting environment, they have been switching mostly out of equities. Given the big falls experienced by the FTSE this year, there may be reluctance to sustain the bid.

If pension funds and insurance companies fail to buy the bonds, the only hope is that overseas investors fill the gap. Foreign central banks and sovereign wealth funds have taken sizable holdings of gilts in recent years and now control more than 30 per cent of the market. But, with sterling so weak – a sure sign that the investment community appears unconvinced about the prospects for the UK – this demand cannot be guaranteed. Indeed, the latest survey data suggests that foreign investors are already exiting UK assets, with heavy outflows recorded from debt markets over the past few months.

An added complication is the emergence of the government-guaranteed bank-funding programme. This scheme was put in place as part of the rescue package for UK banks, the aim being to assist the banks with their funding requirements. Regardless of whether this should be seen as quasi-nationalisation or as a temporary support mechanism, the immediate effect is that gilts now have to compete against a new investment that offers more attractive returns for comparable levels of risk. It is no surprise, therefore, that these bonds have been well received by the markets, with clear evidence of investors switching out of their existing institutional gilt holdings.

It should also be recognised that any additional money diverted into gilts effectively means less elsewhere. The lessons from history are severe – there is soon a point at which government borrowing ‘crowds out’ that of the private sector, with obvious detrimental implications for long-term growth.

In the absence of large-scale buying, the government may be forced to learn a simple lesson: borrowing comes at a cost. If investors demand higher yields in order to entice them to buy the gilts, the funding costs of the Treasury rise. This will be borne by future generation of taxpayers. Maybe the best answer is actually not to borrow. Instead, cut spending to be able to lower taxes.

David Scammell is head of UK interest rate strategies at Schroders