(Bloomberg) — When Rachel Reeves rises to the dispatch box in the House of Commons on Wednesday to deliver her spring statement, the Chancellor of the Exchequer aims to fix a risk of her own making that backfired after her inaugural budget: leaving too small a buffer against her self-imposed fiscal rules.
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To an audience of hostile opposition MPs and facing skepticism from some of her own Labour backbenchers, Reeves will announce billions of pounds of spending cuts to restore the margin she enjoyed in October against her main budgetary target requiring taxes to cover day-to-day spending.
Her headroom was the third-smallest on record at £9.9 billion ($12.8 billion), and has since been erased by higher borrowing costs and weaker growth forecasts. Reeves wants to rebuild it to prove Labour’s fiscal rectitude to skeptical financial markets, according to people familiar with the matter who requested anonymity discussing internal Treasury thinking.
“She made a rod for her own back,” said Ben Zaranko, associate director at the Institute for Fiscal Studies. “She set hard numerical fiscal rules, left herself basically no space against them, and now the forecast has moved.”
The main thrust of Reeves’ argument for her changes will be that the world has changed, one official said, an allusion to global trade disruptions and increased defense pressures since US President Donald Trump came to power. But it was the market selloff following her budget that was the immediate motivation. With her headroom eviscerated, speculation about tax rises, spending cuts and changing the fiscal rules overshadowed other considerations, leaving her to make unwelcome decisions on welfare and spending.
The official downplayed expectations of Reeves putting aside even more cash than in October, saying she has limited levers outside a budget — and indicated that if revenue was required in the autumn, tax rises would be favored over more borrowing.
The pivot for now to spending cuts is a setback for the chancellor, who came into office 8 months ago promising stable public finances after the upheaval overseen by the Conservatives. It’s also a break from her pledge to hold a single major fiscal event a year.
“We’ve got to ramp it up and continue to ensure that we’re doing everything we can to lift living standards and in the end that is through growing the economy,” Reeves told the BBC ahead of next week’s statement. “We can’t tax and spend our way to higher living standards and better public services. That’s not available in the world we live in today.”
Bloomberg Economics expects Reeves to face an extra £17 billion of borrowing needs, with the response coming in the form of spending cuts. She’s already earmarked £5 billion of savings in the welfare budget, while accounting wizardry around her move to cut overseas aid to fund defense gives her another £2.4 billion. That points to about £10 billion to be saved from day-to-day spending.
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The risks for Reeves and her credibility are two-fold: restoring that headroom with spending cuts alone will be tough — departments are already squeezed. And given the huge geopolitical uncertainty, a chancellor would ideally aim for a bigger buffer, but she probably doesn’t have the fiscal or political space to do that.
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The Tories are already seeking to brand Wednesday’s statement as an “emergency budget” made necessary by October’s growth-stifling tax rises. Then, the chancellor levied an extra £40 billion, mainly on business, to fund the National Health Service and education. It sparked an outcry from corporate Britain, depressed business confidence and contributed to reduced hiring — and Reeves has promised there will be no repeat.
But spending cuts are also a tricky sell. The chancellor upset Labour backbenchers by cutting winter fuel payments to most pensioners and through the raid on development spending, and faces a rebellion over welfare cuts unveiled this week that led Chair of the House of Commons Work and Pensions Committee Debbie Abrahams to accuse her party of “balancing the books on the backs of sick and disabled people.”
Many Labour MPs are citing Reeves’ repeated pledge during the election campaign that she wouldn’t return to the austerity-style policies that imposed cuts on public services under the Tories last decade.
Reeves chose to leave little headroom in October to focus on fixing public services, people familiar with her thinking said. Had Britain’s first female chancellor given herself more of a buffer, she would have faced criticism for not spending more where it was needed, one said. Another said she’ll make the case to Labour lawmakers that efficiencies now should be framed in the context of the biggest rise in public spending in a generation at the budget.
The chancellor maintains she made the “right decisions” in October, and has doubled down on her fiscal rules, despite pressure from Labour MPs to relax them.
“It is important that there is headroom against the shocks that we face,” she told Bloomberg TV on Monday. “I don’t think anyone could seriously argue that we don’t need to get a grip of government borrowing and government debt.”
Since the high-tax, high-spending budget, when Reeves was criticized for her gloominess, she’s tried to be more bullish, championing growth initiatives and taking aim at regulators, while stressing a fiscal discipline more commonly associated with past Conservative chancellors.
That means her political standing could be damaged if she doesn’t seek to restore her headroom, according to Ruth Gregory, deputy chief UK economist at Capital Economics. “If she were to not plug the hole, you could get seven or eight months of quite damaging political and economic speculation about what taxes might rise and how far they might rise in the autumn,” she said.
Next week’s spending cuts could be a prelude to a tougher budget in the autumn, when Reeves may have to find more cash. The Office for Budget Responsibility’s estimate of the economy’s potential growth rate, which ultimately determines how much revenue Reeves has to play with, is already far more optimistic than other forecasters, before recent trade tensions are factored in. Michael Saunders, senior economic adviser at Oxford Economics, said he would not be surprised if the OBR chooses to review its forecast over the summer.
But Reeves’ team posit that moves to deregulate will help spur growth and pay dividends in the long run. Before those effects are felt, officials said that Labour’s earlier budgets will be the harder ones, and that the chancellor will revert to tax rises if needed in the fall once she’s exhausted cuts as a way of finding money.
“I don’t think the tough decisions will end here,” said Gregory. “There are clearly big challenges ahead.”
–With assistance from Priscila Azevedo Rocha.
(Updates with Reeves’ comments to the BBC in 8th paragraph.)
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