Labour must get a grip or its entire economic plan could unravel
By Simon French, Chief Economist and Head of Research
Twelve months on from Labour’s General Election landslide, it is a good time to ditch the slogans and soundbites – and I am afraid there will be plenty of those this week - and assess what the latest economic data says about Labour’s stewardship of the UK economy. From my standpoint their record is neither disastrous, nor dazzling. There is a credible argument that things could have been considerably worse given the structural challenges inherited from the Conservatives. Yet a series of policy missteps - some of them avoidable - have needlessly sapped momentum. In essence, Labour’s first year has been defined less by a transformative economic mission and more by steady progress, punctuated by damaging miscalculation.
To give credit where it is due, this government appears to be learning on the job. But it is also true that there has been a lot to learn from - unforced errors on welfare reform, labour market policy and the management of the public finances have blunted early optimism amongst the UK business community. A persistently tricky international backdrop has not helped either.
Let us begin our assessment with GDP - that most central, yet blunt, measurement tool. Growth in GDP since Labour entered office in July 2024 has not collapsed, nor has it accelerated meaningfully. On an international comparative basis, the UK has largely tracked the G7 average, growing by a compound 0.8% in US Dollar terms across the last three quarters. GDP per capita, a more revealing metric of national wellbeing, has risen by a modest 0.3%. This is an improvement after two years of declines, but hardly a stirring renaissance.
Inflation remains central to household perceptions of the government’s economic competency, and the Labour government’s record here is mixed. Headline inflation peaked at more than 11% well before Labour took power and has markedly softened since. However, the core problem - quite literally - lies in ‘core inflation’ which remains stubbornly high at an annualised 3.5%. Above-inflation increases to the National Living Wage and public sector pay have added volatility to service prices just as the Bank of England was seeking calm. April’s spike in CPI, though partially driven by regulated costs like air fares and energy levies, has muddied the water for monetary policy. This dissonance - between a government talking up interest rate cuts and simultaneously fuelling wage pressures - has not gone unnoticed in the Bank’s offices on Threadneedle Street. We should be wary of attributing lower interest rates as the fruit of government policy. They are being delivered despite it.
Turning to fiscal policy and the record is equally chequered. While the cost for the UK government to borrow for ten years - the 10-year gilt yield - has held steady in nominal terms, the interest rate spread that the UK pays compared to its G7 peers has widened to a worrying 1.25 percentage points. This reflects heightened debt issuance pressure after the October Budget, and market suspicion about the UK’s long-term fiscal sustainability. If rebellious Labour backbenchers think this arithmetic magically improves with a change of Chancellor I have some bad news for them. The financial markets see Rachel Reeves as considerably more credible than the vast majority of alternatives within the Labour parliamentary party.
Amidst this backdrop the upcoming autumn Budget now looms large. Having left herself just £9.9bn of headroom against her primary fiscal rule back in March, the Chancellor now faces slippage on multiple fronts. Public sector borrowing has risen faster than forecast. The headwinds from U-turns on welfare reform and winter fuel payments threaten to eat into nearly half of the existing cushion. Visa reforms that suppress labour force growth and murmurings around the two-child benefit cap could further erode fiscal wriggle room.
And the private sector is signalling unease with what is to come on tax. Since the general election, both deposits and the household savings rate have risen. This looks like a quiet vote of no confidence in the economic outlook and shows that speculative fiscal noise has a real cost: muted consumer spending, and deferred investment.
But Labour’s biggest headache is that it has sowed itself problems in the jobs market. Payroll employment, once a bright spot, has stalled since July 2024. Critics rightly argue that recent employer National Insurance increases, combined with expanded employment rights and minimum wage hikes, have depressed hiring appetite.
Two caveats are worth considering. First, payroll data may understate real employment if more workers are now classifying as self-employed to avoid higher employer contributions. Indeed Labour Force Survey (LFS) data - though statistically compromised - shows overall employment still rising. Nonetheless, qualitative data from the Bank of England’s Decision Maker Panel confirms a palpable pullback in hiring intentions. This is consistent with the broader trend: firmer labour market regulation may be well-intentioned, but it is weighing on labour demand.
The second caveat is that green shoots are now emerging in labour market participation, which has inched upward - possibly aided by NHS capacity improvements since the election. Yet the metric that matters most for fiscal arithmetic – productivity - remains worryingly flat. If the Office for Budget Responsibility (OBR) downgrades its productivity assumptions in the coming weeks, the government’s already tight headroom could vanish entirely ahead of the Budget.
So what happens this autumn? The Chancellor faces a vexing equation. Maintain fiscal rules, avoid tax rises on working people (her words, not mine!), protect spending pledges, and hold her parliamentary party together. At least one of these constraints looks certain to give.
Options are narrowing. Loosening rules risks a bond market backlash. New taxes or spending cuts risk backbench revolt and sap economic momentum. Supply-side tweaks - such as speeding up infrastructure approvals or revisiting the North Sea tax and licencing regime - offer some room, but their fiscal payoff is modest and long-term.
The Chancellor may also be tempted to revisit the policy of interest paid on central bank reserves. This is a potentially lucrative move but one fraught with risks to monetary policy effectiveness as her Governor, Andrew Bailey, has recently noted in response to similar proposals from Reform UK. None of these options are easy. Some are not credible. But the current fiscal impasse is even less sustainable.
Yet mere policy competence will not be enough. The fiscal debate is increasingly constrained not by in-year numbers, but by a refusal to confront long term trade-offs on healthcare spending and pensions. If the government truly wishes to spark the “renewal” it promised, it must move from a mindset of management to one of reform. The alternative is a Parliament of drift - marked by tactical retreats, fiscal fudge and faster growth that never quite arrives.
In the months ahead, the OBR’s pen may prove more consequential than the Chancellor’s speeches. Should productivity assumptions fall, the government’s entire economic strategy could yet unravel. The risk, as ever, is not that the centre cannot hold - but that no one dares to grip the centre at all.
