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Rachel Reeves faces a daunting array of fiscal challenges as the new UK chancellor attempts to bolster economic output and avoid steep cuts to fraying public services.
In comments to staff on Friday, Reeves vowed to lead Britain’s most “pro-growth” Treasury and support the industrial strategy that Labour hopes will bolster flagging investment.
“This Treasury will play its full part in a new era of industrial strategy, working hand in glove with business, to make sure Britain is truly open to business once again,” she said.
Reeves took office as the UK’s first female chancellor on Friday against a backdrop of stagnating per capita GDP growth, rising public debt and a record-breaking tax burden.
The formidable landscape contrasts sharply with the inheritance that awaited Gordon Brown when he took the same post in 1997.
During the election campaign, Reeves promised not to raise the main tax rates, which account for three-quarters of total tax revenue.
Instead she pinned her hopes on higher growth coupled with a narrow range of revenue rises worth around £8bn.
But while growth picked up in the first quarter, Reeves is likely to face very limited fiscal headroom for her first budget, expected in the autumn. The figure stood at less than £9bn in March.
“It’s not going to give her loads of money to spend significantly on anything,” said Paul Johnson, head of the Institute for Fiscal Studies. “There may be a few extra billion knocking around if she gets lucky.”
In her comments to Treasury staff, Reeves said she expected the department to do what the Treasury “does best — building growth on a rock of economic stability”.
She also signalled that she wanted the department to focus on new ways of driving up growth.
“It also means taking on new challenges and new responsibilities,” she said, adding that this included driving growth “not just in a few pockets of our country but in every part of Britain”.
Worryingly for Labour, growth forecasts published in March by the Office for Budget Responsibility are more optimistic than the consensus. If they were cut, this would squeeze the Treasury’s budgetary headroom.
The OBR projects 1.9 per cent growth for 2025 and 2 per cent for 2026, above the 1.2 per cent and 1.4 per cent forecast by economists polled by Reuters and figures from the International Monetary Fund.
Labour is eager to find enough cash to avoid a fresh round of public sector austerity. Many analysts expect tax rises to be part of the solution, possibly capital gains tax or inheritance tax.
Andrew Goodwin, chief UK economist at Oxford Economics, said the big fiscal question is whether the government sticks to its election manifesto or adopts a bolder approach given its large majority.
“We think the government will be keen to increase the spending envelope as it becomes clear what the current plans mean for departmental spending settlements,” he said. “Though Labour ruled out increasing most of the main taxes, it could still increase others, such as capital gains tax.”
The public finances are also being weighed down by Bank of England bond sales as the central bank unwinds its quantitative easing programme.
Analysts say the Treasury could gain extra budget space running into the billions of pounds if the BoE dials back those bond sales at its September meeting, when it reviews the programme.
Christopher Mahon at Columbia Threadneedle Investments said an outright halt to active sales of bonds, for example, could save the Treasury £2.5bn in 2025.
Other analysts said that changes to the definition of debt targeted by the Treasury, for example altering the way losses on the BoE’s asset portfolio are accounted for, could help generate some extra budgetary wriggle room.
However Reeves has previously suggested she wants to stick with the definitions currently used by the Treasury.
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