Rachel Reeves is pushing ahead with plans to borrow billions of pounds extra for infrastructure investment, the Guardian has learned, despite concerns about the rising cost of UK government debt.
The chancellor told the cabinet on Tuesday she wanted to change how the Treasury accounted for capital spending to reflect its benefits, as allies say she intends to finalise her debt rule in the coming days.
The move, which will be confirmed to the Office for Budget Responsibility (OBR) as soon as Wednesday, will allow the government to borrow tens of billions more for capital spending over the course of this parliament.
Whitehall sources say she is committed to the plan despite a recent rise in the government’s borrowing costs, which some market experts have blamed on the prospect of higher debt but which others say is more connected to the US economy.
Reeves briefed cabinet colleagues on Tuesday about her budget and the one-year spending review that will be announced at the same time.
Downing Street said afterwards: “One of the first steps of this government is to restore economic stability, and the budget will absolutely deliver on that.”
A No 10 spokesperson said this would mean “delivering on the robust fiscal rules that were set out in the manifesto … that includes debt falling as a share of the economy”.
However, others briefed on the meeting said the chancellor had stressed the importance of capital spending for the economy, in a sign that she still intends to change the debt rule.
Labour committed in its manifesto to balancing day-to-day expenditure with tax receipts, and getting debt falling as a share of the economy in the fifth year of forecasts.
Reeves is believed to be exploring using an alternative debt metric to the one used in the rule she inherited from her Conservative predecessor, Jeremy Hunt.
One option for Reeves is to change the debt measurement to account for the value of the assets the government holds, such as roads, schools and hospitals. Measuring the net worth or the net financial liabilities held by the government could give the chancellor room to borrow as much as £50bn more than currently planned, although some officials worry it would spark a bond market sell-off, with the Treasury left to pick up the bill.
Reeves has talked privately about taking the less radical option of keeping the debt rule in place but excluding losses from the Bank of England from the debt calculation, as well as any extra borrowing used to set up public institutions such as the national wealth fund. This would free up a more modest amount of between £10bn and £20bn and would be less likely to trigger a sharp rise in borrowing costs and interest rates.
The chancellor will on Wednesday send the first draft of her main budget measures to the OBR for officials to draw up their first forecast for how they will affect the public finances.
Alongside a rise in borrowing, Reeves has also been working on a number of tax rises, including levying VAT on private school fees and tightening tax rules for non-doms.
However, her planning has been disrupted by changing analysis of how much each measure could raise, including one Treasury projection suggesting the non-dom changes might raise nothing at all.
The shifting calculations on how much tax she could be able to raise have placed her under even heavier pressure to change the definition of debt to free up money for spending.
Even if the chancellor does choose the more modest changes to the debt rule, she and her chief secretary, Darren Jones, want to change the way the Treasury accounts for the benefits of capital projects in the long term. This could involve publishing 10-year forecasts of the returns that specific investments are likely to generate.
The chancellor’s plan comes against the backdrop of mounting concern about the cost of government borrowing. Since mid-September the annual interest rate on a 10-year government bond has risen from 3.75% to 4.2%, which some market analysts say reflects concerns about Reeves’ budget plans.
Mark Dowding, the chief investment officer at RBC BlueBay Asset Management, told the Financial Times on Monday: “Rachel Reeves needs to walk a tightrope, otherwise the gilt market will limit her ability to deliver much of Labour’s agenda.”
Others say the recent rise in borrowing costs is linked more to a similar rise in the cost of US government debt.
Mohamed El-Erian, the chief economic adviser at Allianz, told BBC Radio 4’s Today programme on Tuesday: “The inclination is to blame that somehow on markets being nervous about the budget. However, the UK operates in a global market. At the same time the US interest rates have gone up by exactly the same amount, and that is due to a much stronger economy there.”
Rupert Harrison, a former adviser to George Osborne, said: “Small changes to the definition of public sector net debt, or even the way the state banks are treated, won’t by themselves alarm markets. But the context is important: we already have the loosest fiscal rules we’ve ever had, with high levels of debt, and the last few years have shown starkly how vulnerable the UK is to changing market dynamics.”
Despite support from many in the Labour party for changing the debt rule, some ministers are concerned that the Treasury is also planning to cut capital spending this year in an effort to close an immediate £22bn shortfall in this year’s accounts.
One minister accused Reeves of sending mixed messages by pursuing capital spending cuts in the short term but promising rises in the longer term. “There is a lack of a strategic approach here, as well as a chaotic process,” the person said.
Reeves will receive the first OBR analysis of her budget measures on Monday – the same day that the government is hosting a summit of international investors in an attempt to encourage foreign institutions to invest in the UK.
Business leaders have queried the wisdom of holding the summit before the budget is announced and while the government is still without an investment minister.
Downing Street said on Tuesday: “[The government’s] first mission is to grow the economy. It set out an ambition in the manifesto to deliver this investment summit within the first 100 days.”
