Reeves has limited options as her maiden Budget looms

Liam Halligan

Sun, Oct 6, 2024, 1:00 AM 5 min read

Rachel Reeves’s Autumn Statement is expected to increase the size of the state significantly - Anthony Devlin/Bloomberg

Bank of England Governor Andrew Bailey has declared that it’s time for the Monetary Policy Committee – the nine economists who set the base lending rate – to become “more aggressive” and “more activist”.

Financial markets duly priced in a 0.25 percentage point reduction in borrowing costs from 5pc to 4.75pc when the MPC next meets on Nov 7. And some City analysts, under pressure to paint a rosy economic picture to allow their businesses to flog more investment products, now predict successive cuts will take rates below 4pc by next spring – a significant drop from the 5.25pc peak.

But for this to happen, as Bailey acknowledged, inflation needs to remain under control. And, for all the City’s predictions, that is by no means a given.

As we enter the final quarter of 2024, it’s clear that the UK – and the broader global economy – is at risk of serious turmoil. And with Labour embroiled in scandal and the Tories still leaderless, domestic politics will be tumultuous too – not least in the run-up to Chancellor Rachel Reeves’s autumn Budget at the end of this month.

Labour’s first major fiscal statement is expected to increase the size of the state significantly, with taxes rising by much more than the £9bn that the party indicated in its manifesto before its election victory on July 4.

Since then, as we have heard ad nauseam, the Chancellor discovered a £22bn gap in the public finances left by the Tories on taking office. That is supposed to explain why taxation will now increase much more than Labour acknowledged before voters went to the polls.

No matter that the independent Institute for Fiscal Studies says, this “black hole” was “obvious to anyone who dared to look” at the national accounts. Reeves and other ministers are now preparing the ground for higher capital gains tax, council tax and possibly employer National Insurance too, while also signalling higher borrowing to boost public sector investment.

The Government borrowed £122bn during the last fiscal year – the most in decades outside of lockdown and the 2008 financial crisis. And our national debt – the sum total of all outstanding borrowing, accumulated over many years – recently topped 100pc of GDP, having surged from 36pc prior to the financial crisis and from 80pc just before the Covid pandemic.

On top of that, the UK is already due to issue £277bn of gilts this year, the highest figure in history except during lockdown, equal to 4.1pc of GDP. But since the Office for Budget Responsibility (OBR) issued that forecast, monthly borrowing has overshot, suggesting the Autumn Statement could push annual borrowing to £300bn or more.

Asset managers and other institutional investors – the private sector players who buy government bonds – are now openly warning that Reeves needs to tread very carefully, indicating that additional borrowing exceeding £10bn-£15bn could cause a backlash, with traders demanding higher yields when gilts are sold.

Already, the Government is poised to spend £89bn on debt interest during this fiscal year – more than double what the state spends on defence, more than it spends on schools. But if the market pushes yields up and debt payments soar even more then public finances could be pulled to pieces causing economic and financial chaos.

Reeves has said she will keep the existing target for public debt as a share of GDP to fall between the fourth and fifth years of the Treasury’s five-year forecast period. But she has studiously not specified which debt measure she would use.

The Chancellor recently stated it is “time the Treasury moved on from just counting the costs of investments, to recognising the benefits too” – in other words, adopting a public debt measure that recognises borrowing to invest as less of a liability than borrowing simply for current spending.

The IFS estimates that targeting a broader notion of “public sector net worth” could add a massive £58bn of fiscal headroom. Inevitably, a slew of Left-wing think tanks and economists are now urging Reeves to do that.

Yet the IFS also warns that “a large increase in borrowing would not be risk-free”, adding that “hiding behind a technicality is not enough”. Bond traders I’ve spoken to at leading institutions have been rather less polite in their analysis.

“Who cares if Reeves used to work at the Bank of England?” one told me, referring to a brief period in the Chancellor’s early career to which she often refers. “Her statements so far point to public finances that don’t add up and that could well cause a market backlash.”

No one could say Reeves faces an easy task – and, despite her disingenuous “£22bn black hole” malarky, she certainly did inherit a fiscal mess from the Tories.

The broader context of her first Budget is also extremely tricky, with the Bank of England’s Financial Policy Committee last week signalling that overvalued share prices and elevated global debt levels means “markets are susceptible to a sharp correction”.

And then of course, amid the latest escalation of conflict in the Middle East, there is the prospect, over the coming three months, of a nasty oil price spike. Crude surged around 8pc last week, with Brent crude testing $80 per barrel – amid fears of a wider war in the Middle East.

With America’s Strategic Petroleum reserve only half-full, US shale bosses are warning the West is now “unusually vulnerable” to an oil price shock – with some traders now predicting $100 oil once more.