Jeff Matsu, Chief Economist
The Labour Government’s new Budget injects £70bn to spur growth and boost a UK economy hampered by slow growth and low productivity. In her first Budget, the Chancellor has steered sharply away from austerity, embracing a larger government role, more muscular industrial strategy and wider plans for devolution. This ambitious approach relies heavily on increased taxes and borrowing, but it leaves little fiscal room to handle future economic shocks.
The government created £50 billion in fiscal space by redefining national debt through a new measure: public sector net financial liabilities. This reclassification allows the government to borrow against a wider range of financial instruments. However, these plans leave only a £16bn buffer by 2029-30, insufficient to cover the estimated £24bn needed to raise defense spending to 2.5% of GDP and overseas aid to 0.7% of GNI, targets Labour hopes to reach once ‘conditions allow.’ If Rachel Reeves had followed the previous fiscal rule, her plan would exceed limits by £6bn.
The Budget also brings the largest tax increase in UK history. Though the Chancellor emphasised her focus on ‘working people,’ roughly half of the £36bn tax increase may impact employees through lower wages. While boosts in the national living and minimum wages could help younger, low-paid workers in the short term, businesses may respond by reducing hiring and investing more in automation, which could raise unemployment and defaults.
This rapid fiscal expansion complicates the Bank of England’s efforts to ease its monetary stance. Delays in lowering interest rates on mortgages and unsecured credit could further strain living standards, with real disposable income growth now projected to be slower than the Office for Budget Responsibility (OBR) had forecast, adding pressure on households.
The Chancellor’s growth plans depend on economic stability, but beyond 2026, spending cuts of 1.1% to 3.5% for unprotected departments are anticipated. These cuts may be hard to implement, especially as council funding has been halved in the decade since 2010 and the criminal justice system is already under severe strain despite a 4% increase in spending next year.
Additional capital funding for the NHS and schools is much needed after years of underinvestment and mounting maintenance backlogs, as highlighted by CIPFA’s Performance Tracker. However, this rapid spending increase could lead to inflationary pressures if supply constraints aren’t addressed, echoing similar challenges from the past.
Long-term sustainability requires funding reform. While Reeves has allocated £1bn for Special Educational Needs and Disabilities, a recent survey by the Association of Local Authority Treasurers suggests the high-needs deficit could double to £8bn by 2026-27, threatening to push councils to the brink. Policymakers need to address these vulnerabilities to ensure financial stability.
To sustain growth beyond 2027, public investment must be effective and consistent. The OBR projects that fiscal expansion could positively impact GDP by the early 2030s, but only if investment levels remain high into the next parliamentary term. However, ongoing economic uncertainties could destabilise these efforts. Small changes in inflation, interest rates or growth could derail the Chancellor’s ability to meet her fiscal stability and investment goals, potentially deterring foreign investors and creating market volatility.
At the recent IMF and World Bank Annual Meetings in Washington DC, officials called for consolidating public finances. After a decade of consecutive crises, global public debt now stands at $100tn, limiting governments’ ability to respond to new challenges. In the UK, Brexit, Covid-19, the cost-of-living crisis and political instability have demanded unconventional fiscal and monetary policies to maintain stability.
Rachel Reeves’ decision to pursue large-scale fiscal intervention comes with significant risks. Should further economic shocks arise, higher taxes may be necessary, potentially complicating her upcoming multi-year spending review, as well as plans for 2027. The success—and sustainability—of her strategy may ultimately be decided by the electorate in the next general election.