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14 January 2025

Labour is paying for its lack of a growth plan

Ministers wrongly believed that ending the Tory psychodrama would be enough to boost the economy.

By David Gauke

It is now looking increasingly plausible that at some point this year, Rachel Reeves will be required to deliver a combination of tax rises and spending cuts to comply with her fiscal rules. It may even happen in March, when the Office for Budget Responsibility (OBR) delivers its next economic forecast. If it happens, whenever that might be, it will be a deeply damaging moment for the government and the Chancellor.

Reeves’ pitch as shadow chancellor was that she would provide stability and strength. After years of drama and crises, she would provide calm. She would be the anti-Truss: prudent, methodical and reassuring. She would have just one fiscal event a year (which has been long desired by Treasury officials), putting an end to frequent policy tinkering. She would be fiscally conservative, quickly taking the difficult decisions to ensure that the UK did not again catch the eye of the bond market. She would be in control.

There is no denying that this reputation is, at the very least, at risk. She left herself little fiscal headroom in her October Budget and growth now looks set to be lower and debt interest costs higher than OBR had then forecast. Having claimed that she had taken the difficult decisions on tax and spend in 2024, being forced to act again in 2025 would be immensely uncomfortable.

If the fiscal rules look set to be broken by the time the OBR publishes its forecasts on 26 March, the easiest response would be to tweak the spending assumptions for the following years. But bond markets are already sceptical about the credibility of her spending plans for the second half of parliament. An unfavourable market reaction at this point would be a significant problem.

Naturally, the debate is currently focused on whom or what is to blame. The matter has come to a head because of movements in the bond markets which are jittery as a consequence of events in the US rather than the UK. The combination of evidence of fast economic growth in the US and fears over Donald Trump’s tariff policy means that expectations of inflation and interest rates have increased. This has caused bond yields to increase across the US and many other countries, including the UK.

When looking at recent market movements, we should not get carried away with comparisons with the events of autumn 2022 after the Truss/Kwarteng mini-Budget. It is true that bond yields are a little higher now than they were then, but the gap between bond yields and the Bank of England base rate was much greater then. As for sterling, it has fallen against the dollar but is still much higher than the near parity that was reached in the aftermath of the mini-Budget.

There is, however, clearly a problem with how the UK is perceived by the markets. Much of that can be put down to Labour’s inheritance in that we have very high levels of debt following Covid and Russia’s invasion of Ukraine (to be fair, that is not really the Conservatives’ fault either), and very considerable pressures on public spending (where the Tories have less clean hands). This left the UK vulnerable to any periods of market turmoil.

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This is where I have some sympathy for Reeves. Much of the criticism she has received as Chancellor is that she is too gloomy and taken too many unpopular decisions. From winter fuel payments to tax increases on employers and those inheriting farms, she is accused of making political mistakes and damaging confidence in the economy. It is true to say that the politics has not been handled adroitly and that business confidence has been hit hard by the big increase in employers’ National Insurance but the fundamental problem was that the country was in a bigger mess than was widely appreciated. If anything, the recent market movements reveal that Reeves took too rosy a view of the nation’s prospects by increasing short-term borrowing by £30bn in her Budget to fund major short-term increases in public spending. The uncertainty caused by a Trump electoral victory was hardly unforeseeable.

The second ground of legitimate criticism of the government is that, for all its rhetoric, it has had an insufficient focus on economic growth. Too much hope was invested in the belief that ending the Tory psychodrama, and reforming planning laws, would be sufficient to get the economy moving again. Treasury officials – expecting to be presented with a growth plan to be implemented – were mystified to discover that there was no such plan. Months after coming to office, there is still a sense that ministers are scrambling around trying to find one.

For the country’s sake, let us hope that they succeed. What is not available is the approach Labour long advocated in opposition – higher public investment funded by higher borrowing. Whatever the case for this 10 to 15 years ago, the markets will not wear it today. Instead, fiscally-neutral supply-side reform is necessary. Proceed with planning reform that allows more houses to be built, but particularly where people want to live (get really radical with the Oxford to Cambridge arc). Show much more ambition in increasing market access to the EU. Cut energy costs for businesses. Reduce the regulatory burden on businesses rather than adding to it by extending costly employment rights.

None of this is politically easy. But, in terms of political pain, it has to be compared with the implications of a further round of spending cuts or tax increases. This is a prospect the government should really fear.

[See also: Donald Trump’s empire of ego]

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