Reeves faces tough fiscal choices as Treasury chief ‘pro-growth’

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Rachel Reeves faces a series of huge financial challenges as Britain’s new prime minister tries to boost economic output and avoid deep cuts to struggling public services.

In comments to staff on Friday, Reeves pledged to lead Britain’s most “pro-growth” Treasury and back an industrial strategy that Labour hopes will boost faltering investment.

“This Treasury will play its full part in this new era of industrial strategy, working closely with business to ensure that Britain is truly open for business again,” she said.

Reeves takes office as the UK’s first female prime minister on Friday amid stagnant GDP per capita growth, soaring public debt and a record tax burden.

This majestic landscape is in stark contrast to the legacy Gordon Brown left behind when he took office in 1997.

During the election campaign, Reeves promised not to raise the core tax, which accounts for three-quarters of all tax revenue.

Instead, she is pinning her hopes on higher growth alongside a narrow revenue increase of around £8bn.

But while growth picked up in the first quarter, Reeves is likely to face little financial headroom for his first budget, due in the autumn, which stood at just under £9bn in March.

“It won’t give her much money to spend significantly on anything,” said Paul Johnson, director of the Institute for Fiscal Studies. “Maybe a few billion more if she’s lucky.”

In her comments to Treasury staff, Reeves said she expected the department to do what Treasury “does best — build growth on a foundation of economic stability.”

She also hinted that she wants the division to focus on new ways to drive growth.

“This also means taking on new challenges and responsibilities,” she said, adding that this included driving growth “not just in a small number of places in our country but everywhere across the UK”.

Worryingly for Labor, the growth forecasts published by the Office for Budget Responsibility in March were more optimistic than consensus. If they are cut, this will reduce the Treasury’s ability to spend the budget.

The OBR forecast growth of 1.9% in 2025 and 2% in 2026, higher than the 1.2% and 1.4% forecasts of economists polled by Reuters and figures from the International Monetary Fund.

Labour is desperate to find enough cash to avoid a new round of public sector austerity. Many analysts expect tax increases to be part of the solution, perhaps capital gains tax or inheritance tax.

The big fiscal question is whether the government sticks to its election manifesto or takes a more aggressive approach given its majority, said Andrew Goodwin, chief economist at Oxford Economics.

“We think the government will want to increase spending when it becomes clear what the current plans mean for the department’s spending options,” he said. “While Labor has ruled out raising most major taxes, it could still raise others, such as capital gains tax.”

Public finances are also being hit by the Bank of England’s bond sale as the central bank winds down its quantitative easing programme.

Analysts say the Treasury could get billions of pounds of extra budget space if the BoE cuts bond sales at its September meeting, when it reviews the programme.

Christopher Mahon at Columbia Threadneedle Investments said ending bond sales could save the Treasury £2.5bn by 2025.

Other analysts said changes to the Treasury’s definition of debt, such as changing how losses are accounted for in the BoE’s asset portfolio, could help create more room for the budget to maneuver.

However, Reeves has previously suggested that she wants to keep the definitions currently used by the Treasury Department.