LONDON: Chancellor of the Exchequer Rachel Reeves’ repeated warnings about the perilous state of the UK’s public finances have been so successful she has turned her budget this month into an inflection point for the economy.

Reeves is barrelling towards a career-defining financial statement on Oct 30 facing a broad and sharp decline in sentiment among consumers and businesses, which economists widely attribute to fears about her plans to fill a £22bil (US$29bil) financial hole.

While the left-leaning Labour Party’s first budget in 15 years was bound to have lasting consequences, Reeves’ doom-laden narrative has made it a moment of short-term risk, as well.

“It was always going to be a high-stakes budget, but there is certainly pressure to deliver now,” said Hetal Mehta, head of economic research at St James’ Place.

The chancellor’s statement to the House of Commons in less than four weeks will follow a succession of surveys and reports showing doubts rippling through what had been a surprisingly strong economy. Consumer confidence, measured by the monthly GfK index, tumbled the most since Russia’s invasion of Ukraine 2½ years ago and a British Retail Consortium survey showed households expect the economy to deteriorate.

Business chiefs are the most pessimistic they have been about the economy since the aftermath of the-Prime Minister Liz Truss’ disastrous “mini-budget” two years ago, according to the Institute of Directors. Employers are switching to temporary recruits, a tactic used in periods of uncertainty, the Recruitment and Employment Confederation found, and the jobs market is seizing up as employers anticipate restrictive new hire and fire rules.

Such data has fuelled doubts within Prime Minister Keir Starmer’s three-month government over the budget messaging, which has included a controversial cut to heating subsidies for pensioners and efforts to cut capital spending.

The deteriorating outlook puts an enormous amount of pressure on Reeves to shift the narrative and pins Starmer’s success almost entirely on her own, one influential Labour Member of Parliament said.

“It is a budget people are apprehensive about instead of one they could have been more hopeful for,” said Kallum Pickering, chief economist at Peel Hunt.

“They have over-egged the misery pudding. They didn’t need to.”

Despite Labour’s warnings about tough decisions and the threat of tax rises for those with the “broadest shoulders”, the party inherited an economy that grew faster in the first six months than any other member of the Group of Seven, beating even the most optimistic expectations.

Last month, the Organisation for Economic Cooperation and Development upgraded its UK growth forecasts by far more than other major economies.

Indeed, household and corporate balance sheets are strong.

Retail sales have been better than hoped and mortgage approvals, aided by falling interest rates and rising house prices, are at their highest since Truss’ budget sent borrowing costs soaring.

Businesses continue to expand steadily, with construction growing at its fastest rate in 2½ years.

“For now, we are miserable, but we are still spending,” Pickering said.

The danger Reeves faces is that weakening sentiment starts to shape reality and the recovery stalls. Anxiety has festered in the long wait between the “financial black hole” the chancellor revealed on July 29 and the budget she said must fill it.

The unexpected budget gap provided justification for tax rises not mentioned in Labour’s election manifesto, but the accompanying warnings about the need to cut spending and raise taxes shattered the post-election cheer.

Some rich individuals have disclosed plans to leave the United Kingdom.

The chancellor is alert to the risk. In her party conference speech, Reeves stressed that while every choice she makes in the budget “will be within a framework of economic and financial stability”, the overriding priority will be growth.

“Growh is the challenge. And investment is the solution,” she said.

Alongside Starmer and Energy Secretary Ed Miliband, she unveiled a £21.7bil project to accelerate Britain’s carbon capture industry in northern England last Friday.

“Investment was not prioritised by the last government. I am not going to make those mistakes,” she said.

Mehta said Reeves appears to be back-peddling into a more optimistic narrative as part of what looks like becoming a relaunch budget.

“Expectation plummeted too far and they are having to reassess just how downbeat they want to be. With sentiment fragile, they need a good news story,” Mehta said.

“The balance is shifting from doom and gloom on tax rises to being more hopeful on investment.”

Reeves signalled in her speech to Labour’s annual conference on Sept 23 that she was planning to alter the financial rules to allow growth-enhancing investment.

Pickering said the change of emphasis was welcomed and that the earlier downbeat messaging was a “mistake”.

“With the proper guidance, she could have got markets on side for raising more debt,” he said, particularly for investment. Even the £22bil “is not enough to upend markets”.

George Buckley, chief European economist for Nomura, said a bit more borrowing will be needed to fund Reeves’ investment-driven growth push.

“It seems likely the chancellor will allow higher deficits to take some of the strain,” he wrote in a note last Wednesday. “Increased spending plans, especially directed towards investment, could be positive for the economic outlook.”

In a further sign that she may borrow more, Reeves is now considering tweaks to the her overhaul of the UK’s “non-dom” tax regime for wealthy foreigners, after Treasury analysis showed it may cost the exchequer by driving away the rich. 

 - Bloomberg