Rachel Reeves has blamed a heavier than anticipated blow from Brexit and austerity for forcing her to take action to balance the books at next month’s budget.
In her clearest attempt to draw Brexit into the framing of her imminent tax and spending decisions, the chancellor said leaving the EU was turning out to have caused more damage than official forecasters had previously outlined.
The chancellor hinted she was braced for a sharp downgrade in growth forecasts from the Treasury’s independent watchdog, the Office for Budget Responsibility (OBR), alongside what is shaping up to be a crucial budget.
“The OBR, I think, are going to be pretty frank about this – that things like austerity, the cuts to capital spending and Brexit have had a bigger impact on our economy than was even projected back then,” she said at an investment event in Birmingham.
“That is why we are unashamedly rebuilding our relations with the EU to reduce some of those costs, that in my view were needlessly added to businesses since 2016 and since we formally left a few years ago.”
The chancellor’s intervention comes amid growing confidence within Keir Starmer’s government to speak out about the damage of Brexit, as the decision to leave the EU almost a decade ago continues to weigh heavily on Britain’s economic performance.
It also marks an opportunity for Labour to tackle rising support for Nigel Farage, with the prime minister recently attacking the Reform leader for “walking away” from the leave vote without a plan.
In an interview with the Guardian on the sidelines of the government’s first regional investment summit at Edgbaston cricket ground, she said Labour could “defy the past and do better”, because the government was prepared to rebuild relations with Brussels, slash planning regulation and invest in infrastructure.
“It is why I am putting so much emphasis on growth and productivity, because the numbers have been really bad in the last decade-and-a-half, and I am determined to turn that around.”
Reeves was speaking before official figures on Wednesday were expected to show another tick up in UK inflation. Economists polled by Reuters were predicting the annual inflation rate would rise to 4% in September from 3.8% in August. That would be double the government’s 2% target.
The chancellor is keen to announce measures at the budget to bear down on prices, where these can be influenced by policy.
She is expected to chair a meeting of cabinet colleagues on Thursday to ask what each department can do to tame inflation. A Treasury source said: “The chancellor’s view is that tackling the cost of living is urgent, and everything is on the table – including measures to bring down energy bills. She’s getting the whole of government to play its part, it’s her No 1 focus.”
Reeves is widely expected to announce a package of tax increases and cuts to spending at the budget on 26 November in response to a shortfall in the government finances that could reach up to £40bn.
The OBR is understood to have handed sharply downgraded forecasts to the chancellor, fuelled by a stark reassessment of Britain’s productivity growth, soaring borrowing costs and the financial hit from the government’s high-stakes welfare U-turns. The latest figures from the Office for National Statistics on Tuesday showed government borrowing over the first six months of this financial year was £99.8bn, £7.2bn more than forecast by the watchdog in March.
At the heart of the OBR’s downgraded forecasts is expected to be a sharp cut in its assessment of Britain’s productivity performance, based on flatlining progress in the past decade since Brexit.
The forecaster has previously admitted it has been too optimistic about the British economy’s prospects for growth. A downgrade in productivity forecasts of just 0.2 percentage points would be enough to leave a £14bn hole in the government finances by the end of the decade.
Last week the governor of the Bank of England, Andrew Bailey, warned Brexit would have a negative impact on the UK economy for the “foreseeable future”. Previously the OBR has said leaving the EU would reduce Britain’s long-term level of productivity by about 4%.
It comes as erecting tougher trading barriers and adding reams of red tape for business dealings with the country’s single-largest trading partner has weighed heavily on the productivity growth of the British economy.
Speaking to an audience of 350 business leaders, regional mayors and investors on Tuesday, including HSBC, Lloyds Banking Group, Legal & General and KPMG, Reeves warned that any shortfall in the public finances would require immediate action.
Hinting that any measures in next month’s budget would at least rebuild her headroom against her self-imposed fiscal rules, she said: “I will ensure that the sums add up; that we have that buffer against future shocks.”
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At the spring statement in March, Reeves kept £9.9bn in reserve against her main fiscal rule, which requires day-to-day spending to be matched by revenues by the end of the current parliament.
The chancellor said that failure to take corrective action could trigger a negative reaction in financial markets, drawing parallels with Liz Truss’s ill-fated-mini budget in September 2022.
“If we came out of the budget with plans that investors in government bonds and financial markets recognised didn’t add up, we will see what happened to Liz Truss and [the then chancellor] Kwasi Kwarteng happen again, which is borrowing go up for consumers and businesses.”
However, Reeves argued Labour would take an approach distinct from previous Conservative administrations by prioritising investment in long-term infrastructure – ruling out austerity to lay the foundations for stronger growth in future. The chancellor also said cutting business regulations and planning rules was a priority to spur economic growth.
“The reason we’ve got low growth today is they cut capital spending in the past, and we’re paying the price for that today,” she said.
Reeves told the Guardian that her budget would rule out any cuts to long-term infrastructure spending, saying that spending on transport infrastructure, energy and other productivity-enhancing measures was vital for drawing in private sector investment.
She said the decision to rule out cuts to capital investment was only possible because of the changes she made to her fiscal rules last autumn, which included separating requirements for the day-to-day budget to allow the government to borrow to invest.
“I know I get a lot of criticism for [the fiscal rules], but without those changes, I wouldn’t be able to sit here and say the capital budget is protected. And it absolutely is.”
Reeves is also planning a £2bn tax raid on lawyers, doctors and accountants as she looks to increase taxes on wealthier workers to fix her budget hole.
The chancellor is planning to raise national insurance on people who are employed through limited liability partnerships (LLPs), which are most commonly used in the legal profession.
Such workers currently pay no employer national insurance and a lower rate of employee national insurance.
Reeves is planning to set a new rate at just below the 15% rate of employers’ national insurance, according to government insiders, confirming a story first revealed by the Times.
The policy has been supported by the Centre for the Analysis of Taxation and the Institute for Fiscal Studies.