The Treasury was ready when Labour arrived in office. In the week after the election landslide, ministers and a cadre of advisers appointed to serve at 1 Horse Guards Road were gathered together by civil servants, and shown a 25-minute PowerPoint presentation laying bare the mess in the public finances.
Those in attendance were left in no doubt: this was an exercise to scare the new recruits. A shock session to get Labour up to speed with its responsibilities, and to make sure Rachel Reeves prioritised fiscal prudence in her first budget.
Leaning into the doom and gloom wasn’t tough for the chancellor. Painting the Conservatives as the party of fiscal irresponsibility was exactly the message Reeves wanted to send after winning power, helped further by Treasury analysis she commissioned showing a £22bn “black hole” in the public finances.
It’s clear the exchequer was in a shaky condition. Deep tax cuts – made in a last ditch attempt to save Rishi Sunak – had been matched with “work of fiction” spending plans by the Tories, laying the ground for higher borrowing or renewed austerity. Debt as a share of the economy was on track to reach 100%, the highest level since the early 1960s.
But it also didn’t ring entirely true. Lucy Powell, the leader of the Commons, was accused of exaggerating the financial market risks after warning of a possible “run on the pound” if the government had not made immediate spending cuts when it revealed the fiscal pressures. However, there was little sense of this in the City, after a stabilisation in gilt yields, exit from recession, cooling inflation, and the Bank of England cutting interest rates.
In the past week, however, Labour has begun to pivot away from its previously gloomy message. Reeves hinted in her conference speech in Liverpool last week that she would relax the government’s self-imposed fiscal rules, helping to find more headroom for investment.
It was “time that the Treasury moved on from just counting the costs of investments to recognising the benefits too”, she said.
Several of those who told Labour everything was fine, now warned there was a serious risk of a market upset after all, should the chancellor move the goalposts too far. So which is it?
The truth is the balance lies somewhere between the two extremes. Somewhere between applying a George Osborne-style handbrake on the economy, and the brick on the accelerator approach of Liz Truss.
Jagjit Chadha, the director of the National Institute of Economic and Social Research, says most investors know the fiscal rules are well beyond their sell-by date. “If you’re clear about what you’re going to do with what you’ve raised in terms of finance, and you have institutions that can deliver the appropriate return, the markets would not be scared.
“The gilt market is not some monster that will bite your hand off.
“We need to be grown up about the level of debt that it is where it is, and make the case that it is where it is to rebuild the country, after a period of national degradation.”
One minister said they and their colleagues had grown convinced of the need for action in recent weeks. “You have to crack on and do things quickly if you want voters to see progress.”
While Reeves sees fiscal prudence as important, she knows that a refusal to boost investment would also be an irresponsible act; by cutting back on the things that can help to boost growth, and the public finances, in future. The is the catch-22 the UK has been facing for 15 years, in a doom loop that needs to be broken.
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Next month Reeves is preparing to focus on three main objectives for her budget: Protecting the incomes of working people; fixing the problems in the health service; and rebuilding Britain’s economic foundations.
The first task will be about boosting the resilience of family finances, given that living standards fell lower at the end of the five-year term than they were at the beginning.
That will involve sticking to a message of stability. The chancellor believes “tough” decisions will be needed to balance day-to-day expenditure with tax receipts. She will say stable inflation – helping to bring down mortgage rates – is among the prizes available from a commitment to economic and fiscal prudence.
Reeves is planning reforms to prioritise good jobs, paying decent wages, particularly in parts of the country that need them most. This will include raising investment and strengthening workers’ rights. But the chancellor will face ongoing criticism for scrapping winter fuel payments for all but the poorest pensioners.
Second, fixing the problems in the health service. Here the chancellor will need to commit to spending increases and reform. Beyond fixing the health service for the good of the nation, this priority is also an economic necessity; to tackle record levels of long-term sickness keeping working-age adults out of the jobs market.
Third, unlocking investment. This will be central to Reeves’s plan, as the key to stronger economic growth in future. Here the chancellor will prioritise Labour’s new investment institutions, GB Energy and the National Wealth Fund.
But she will also push to change the infamous Treasury view, with a drive to change its culture away from one of a doom-laden fiscal department, to one focused on economic growth.
If the chancellor’s plans work, the prize on offer is higher living standards, paying decent wages, and generating more income for the exchequer without the need for her to raise a single tax rate.
