The Chancellor had hoped {that a} blowout public spending binge, funded by additional borrowing and better taxes, would assist her turbocharge progress and redraw the nation’s financial map. As an alternative, her ambitions lie in tatters.
Not solely has her tax-raising Funds trashed enterprise confidence and stunted the financial system, however a surge in borrowing prices has additionally worn out her fiscal headroom.
And that’s with out contemplating Donald Trump’s escalating commerce battle, which has unleashed a wave of financial turmoil that Reeves has blamed for damaging progress.
Nevertheless, worse should be to come back, because the Financial institution of England warned on Thursday that inflation is on the rise.
Crucially, this dangers rates of interest staying larger for longer, one thing the Chancellor can unwell afford.
If it was merely a matter of the financial system failing, Andrew Bailey, the Financial institution of England Governor, and his colleagues on the Financial Coverage Committee might minimize rates of interest from their present stage of 4.5pc to shore up progress.
Nevertheless, regardless that GDP floor to a halt within the second half of final yr and shrank by 0.1pc in January, rate-setters are reluctant to behave due to revived inflationary pressures.
The headline fee rose to 3pc in January, effectively above the 2pc goal, with policymakers already warning that this can solely enhance within the coming months.
“Home worth and wage pressures are moderating, however stay considerably elevated,” the MPC mentioned. “Though world power costs have fallen again just lately, they continue to be larger than final yr and CPI inflation remains to be projected to rise to round 3.75pc in 2025 Q3.
“Whereas inflation is predicted to fall again thereafter, the Committee can pay shut consideration to any consequent indicators of extra lasting inflationary pressures.”
These pressures are most evident within the jobs market, the place common common pay within the three months to January was up 5.9pc, effectively above ranges which might be according to the 2pc inflation goal.
Public sector pay can be accelerating, with progress rising to five.3pc, its highest stage since final summer time.
Regardless of employers chopping again on hiring amid tax rises, pay is about to extend once more sharply subsequent month forward of one other 6.7pc soar within the nationwide residing wage.
This fuels inflation, notably in companies which might be linked carefully to wages.
That is dire information for Reeves.
A one-off burst of inflation can work in a Chancellor’s favour, eroding the nationwide debt in comparison with the cash-terms measurement of the financial system.
As such, inflation is one issue that has helped hold the debt beneath 100pc of GDP regardless of ballooning from £1.8 trillion to £2.8 trillion over the previous 5 years.
It additionally rakes in more cash for the Exchequer. VAT is charged as a share of costs, and the thresholds for earnings tax are frozen in money phrases. So whilst employees’ wages rise to match larger costs, a much bigger share flows into the general public purse.
However the larger hazard comes from borrowing prices.
The Financial institution of England elevated rates of interest in the price of residing disaster. As inflation spiralled to 11.1pc in 2023, Bailey and his colleagues on the nine-strong MPC raised charges from 0.1pc to five.25pc.
Solely in August 2024, when inflation was again down at 2.2pc, had been they sufficiently assured to chop charges.
However now inflation is rising once more, hitting 3pc in January. Increased power payments are additionally set to take it to three.75pc later this yr, the Financial institution predicts.
Chaos within the world buying and selling system, with Trump slapping tariffs on imports from overseas, raises the spectre of a repeat of the pandemic-era crunch which noticed items costs surge.
Bailey desires to make sure that doesn’t end in one other wave of companies ramping up costs and employees demanding extra pay, in what is thought in central banking circles as “second spherical results”.
“Ought to there be extra constrained provide relative to demand and extra persistence in home wages and costs, together with from second-round results associated to the near-term enhance in CPI inflation, this could warrant a comparatively tighter financial coverage path,” the MPC mentioned, setting out the dangers.
In the end policymakers concluded on Thursday that “financial coverage would want to proceed to stay restrictive for sufficiently lengthy till the dangers to inflation returning sustainably to the 2pc goal within the medium time period had dissipated additional”.
Nevertheless, the longer the MPC waits, the upper inflation will rise above their goal and the more durable policymakers could discover it to justify fee cuts, even when they count on worth rises to gradual once more subsequent yr.
The eight-to-one vote in opposition to chopping charges bolstered the MPC’s promise of solely “gradual and cautious” fee cuts, indicating little reduction any time quickly for hard-pressed debtors, together with the Authorities and Rachel Reeves.
