(Bloomberg) — Chancellor of the Exchequer Rachel Reeves will favor fresh cuts to public spending over tax hikes if soaring UK borrowing costs wipe out her fiscal headroom.
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Reeves plans to reaffirm her fiscal rules in a speech in the coming weeks aimed at reassuring investors and businesses about her handling of the economy, according to people familiar with her plans. She will argue that Prime Minister Keir Starmer’s Labour government will prioritize stability and not consider any loosening of budgetary guidelines, said the people, who asked not to be identified discussing unannounced proposals.
Scruntiny on Reeves’ fiscal plans is growing, with the UK among the hardest hit by a rout in global bond markets this week driven by investor concerns over levels of public debt. The sudden rise in gilt yields is threatening to absorb the slim £9.9 billion ($12.2 billion) margin Reeves had left after announcing her first budget as chancellor in October.
If debt costs remain at this level through the next round of Office for Budget Responsibility forecasts due by March 26, she could breach her main fiscal rule against borrowing to fund day-to-day spending. In such a scenario, she would favor departmental cuts rather than coming back for more tax rises like the £40 billion of revenue-raisers in the October plan, one of the people said.
“There’s always a range of global factors which drives market movements,” Starmer spokesman Dave Pares said on Wednesday. “We will always put economic stability and sound public finances first.” Meanwhile the Treasury said in a statement that “meeting the fiscal rules is non-negotiable.”
Labour has prioritized fiscal stability to set itself apart from the former Conservative government, which suffered an ultimately fatal drop in public support after Prime Minister Liz Truss’s uncosted tax and spending plans roiled markets in September 2022. The rout of recent days has brought numerous unfavorable comparisons to the “mini-budget” saga, with rates on inflation-linked 30-year gilts exceeding 2% for the first time since Truss’s tenure. Benchmark 10-year yields jumped as much as 14 basis points to 4.82% on Wednesday, the highest since August 2008.
“If market pricing sticks, then the fiscal rules are probably going to be breached in the UK and they’re going to have to come back and do more,” Jamie Rush, Bloomberg’s chief European economist, said on Tuesday.
The chancellor’s two main rules are to have tax receipts cover day-to-day spending and for debt to be falling as a share of the economy.
The former Bank of England economist’s own credibility is at stake since she has promised to limit herself to only one fiscal event a year and vowed not to raise broad-based taxes. A £26 billion increase in employer payroll levies included in the October budget has contributed to a decline in business and consumer sentiment, prompting Reeves to promise British executives she was “never” going to draft another spending plan like that one.
Sticking to those pledges would leave Reeves with only spending cuts to rebuild her surplus. Some departments’ budgets could be squeezed if necessary, another person said. Still, any effort by the Treasury to reduce ministers’ spending would likely cause disquiet across the cabinet, with ministers worried that voters won’t tolerate a further decline in public services that suffered last decade under Tory austerity policies.
Ahead of the last spending review published alongside the budget, Reeves faced a rebellion from senior ministers who protested to Starmer about cuts she was asking them to make. That highlights the potentially serious political dangers of fresh cuts for the center-left Labour government.
To manage such risk, the Treasury is planning to hold meetings with multiple cabinet members at a time to discuss the tight public finances, rather than repeat the one-on-one sessions that were typically held by Chief Secretary to the Treasury Darren Jones at the previous spending review. That could help the Treasury explain to ministers that if they want to protect their own budgets, they would have to help find savings in their colleagues’ departments, a person familiar with the matter said.
While stressing that fiscal stability is non-negotiable, Reeves’ upcoming speech will focus on which levers she can pull to get growth going. Growth is the No. 1 mission of the government and the chancellor would leave no stone unturned in her determination to deliver it, a person close to her said. That would include looking at exploring further opportunities in regulation, planning reform and closer ties with the European Union and China, they added. Reeves is traveling to Beijing and Shanghai in the coming days in an effort to mend relations.
Reeves also recognizes that the budget was a blow to corporate Britain and is keen to make more business-friendly noises in the coming months. She has been meeting executives almost daily in recent weeks, hearing their concerns in preparation for her upcoming speech, one of the people said.
She is also planning speeches for priority sectors of the economy, envisioned as small versions of her annual policy address at Lord Mayor’s Mansion House residence. Treasury officials reported that they received positive feedback and ideas from the City of London in the six weeks before the chancellor’s Mansion House in November, and they now want to do the same for other parts of the economy.
–With assistance from Greg Ritchie and James Hirai.
