Rachel Reeves, the Chancellor of the Exchequer, faces a significant fiscal challenge as the ongoing crisis in the Middle East threatens to erase a substantial portion of the £24bn headroom she built against her fiscal rules. According to Treasury sources, weaker economic growth and higher borrowing costs could wipe out between half and two-thirds of this buffer, undermining the government's fiscal strategy.
Economic Recovery Under Threat
Just weeks ago, the UK economy appeared to be turning a corner. Official data showed GDP growth of 0.5% in February, unemployment fell, and public borrowing decreased by £20bn in the year to March. Inflation was trending towards the 2% target, and the Bank of England was expected to cut interest rates further. However, the US-Israeli attack on Iran has disrupted this positive trajectory.
Ruth Curtice, chief executive of the Resolution Foundation, noted: "Growth, unemployment, inflation, public finances: they were all just ticking the right way." She added that the crisis comes at a particularly unfortunate time, as the economy was emerging from a period of stagflation-like conditions.
Impact on Fiscal Headroom
The headroom Reeves created by raising taxes last autumn is now at risk. Deutsche Bank's chief UK economist Sanjay Raja stated that the OBR's growth forecast of 1.1% looks outdated, with downside risks to growth and employment, and upside risks to inflation. Higher oil prices, hovering around $100 per barrel, have reversed improvements in bond market sentiment, driving up gilt yields.
If the crisis persists, Reeves may face severe constraints in her autumn budget, especially with pressures for increased defence spending and support for vulnerable households. She has ruled out a "kneejerk response," emphasizing targeted measures to avoid exacerbating inflation and borrowing costs.
Political Context
Reeves has adopted an assertive stance, blaming external factors rather than her own policies. Shadow Chancellor Mel Stride countered: "Rachel Reeves can blame the world all she wants, but it's her choices that have weakened our economy." Meanwhile, some speculate that a potential Labour leadership contest could liberate Reeves from Treasury orthodoxy, as she hinted at structural changes she hopes will outlast her tenure.
At the National Growth Debate, Reeves warned against repeating the Conservative era of political instability, stressing that "stability is the foundation of everything else." Her recent portrait acquisition by the parliamentary art collection has been seen as a valedictory gesture, though she remains focused on navigating the current crisis.
