Chancellor Rachel Reeves used a surprise early morning speech on Tuesday to set the context for the forthcoming Budget for voters and markets ahead of her upcoming Autumn Budget on 26 November, signalling a continued focus on fiscal discipline while warning of difficult decisions to come.
Reeves said the current weak productivity, high borrowing costs and stubborn inflation were shaped by "years of economic mismanagement" by previous governments, including a £22 billion black hole left by the previous government.
She said Brexit, austerity, and underinvestment were factors that weakened the UK’s preparedness ahead of recent economic shocks, with a continual threat of tariffs having dragged on global confidence this year.
Kemi Badenoch responded to the Chancellor’s pre-Budget speech, saying it was “one long waffle bomb”.
Speculation has been building that the government may move to raise income tax or alter tax thresholds to address a significant shortfall in the public finances.
The budget will include a review of productivity from the Office for Budget Responsibility, examining the supply side of the UK economy, where Reeves said the issue was not to do with workers themselves but because they "don’t have the tools that they need”, such as "trains that run on time".
Adding reduced productivity into the Budget calculations means lower economic growth and tax revenue, while also increasing reliance on public services and welfare, widening the gap in public finances from both sides.
Around £31 billion of fiscal consolidation, ie spending cuts and tax increases, will be needed as a result, according to the Resolution Foundation thinktank, which calculates that this will require tax rises worth an estimated £26 billion.
Reeves reiterated her commitment to maintaining fiscal rules, stating that “the less we spend on debt interest, the more we can spend on the priorities of working people.”
Market reaction pointed to confidence in fiscal responsibility being maintained, with bond yields falling initially, before returning to where they were yesterday.
Tough decisions needed
Market analysts said the main takeaways were that Reeves is seeking more fiscal headroom than the £9.9 billion left in at spring statement in order to protect against future shocks, while refusing to the manifesto promises not to raise income tax, national insurance, or VAT.
Economist Andrew Wishart at Berenberg said it was "encouraging" that Reeves had made a "commitment to inflation and public debt reduction at the expense of the Labour party’s manifesto commitment to not raise certain taxes".
He says the "major tightening" of fiscal policy that Reeves was suggesting is coming at the budget announcement "could create a virtuous feedback loop to lower interest rates and public borrowing, even if it is delivered by tax hikes rather than spending cuts".
Wishart said a broad-based tax hike at the budget would be "far less damaging to economic incentives than the hodgepodge of measures that would be necessary to raise large amounts from high-income and wealthy individuals".
Sarah Coles, head of personal finance at Hargreaves Lansdown, said: "The scale of the financial challenges for the government right now mean the Budget is likely to involve some incredibly tough decisions."
She said the fact that Reeves made speech at all is demonstrates that "the government wants to highlight its position: to meet its fiscal rules, it’s likely to have to make spending cuts and raise significantly more tax".
With the speech seemingly laying the ground to go against a manifesto pledge, where Labour said it would not raise any of the big three: income tax, National Insurance or VAT.
"Given that VAT runs the risk of being inflationary, it could put income tax front and centre," said Coles.