Cautious Course: Reeves and the Budget Rules in Focus

The waves of fiscal policy could rise higher in the coming weeks as the British government, led by Rachel Reeves, faces a crucial direction choice. Ahead of the budget on October 30, the question arises as to how far the government is willing to loosen current debt guidelines to allow for more public investment. The renowned Institute for Fiscal Studies (IFS) recently published an analysis showing that by taking a broader view of public finances, room for additional investments amounting to over 50 billion pounds could be created. However, Carl Emmerson, deputy director of the IFS, warns against excessive use of this financial leeway. Despite the additional space, the interest payments on the debt would increase, which is why caution is needed. For the investments to remain effective, Emmerson emphasizes the necessity to support carefully selected programs that demonstrably lead to growth. Ben Nabarro, an economist at Citi, highlights that Reeves must ensure that the newly acquired budget capacity is not fully utilized to maintain the confidence of international investors. For them, there is no distinction between borrowing for urgent needs and investments — the overall picture matters. Currently, investors in the gilt market nervously anticipate the possible realignment of fiscal rules within the budget. The current regulations require the debt ratio relative to GDP to decrease over the years without adequately considering public assets. An adjustment that accounts for the total net worth of the public sector could, however, provide Reeves with more financial leeway. Nevertheless, the evaluation of such assets, like roads and railways, remains uncertain and of little significance in terms of creditworthiness in the gilt markets, according to Paul Johnson, director of the IFS. To secure investor support, it is crucial that Reeves makes it clear she will use the leeway judiciously and gradually — with solid institutional guardrails to ensure effective use of funds. Reeves also faces the challenge of managing the ongoing costs for public services, especially regarding funding public pay raises and meeting her party’s election promises. According to the IFS, an increase in tax revenue by 25 billion pounds is needed to accommodate expenditures in line with the growth of national income.