The chancellor and prime minister will begin to pitch-roll tax rises and reforms from September as part of a strategy to prepare the country for a difficult budget that could be held in November, the Guardian has been told.
Although Treasury sources have insisted Rachel Reeves will stick to her pledge not to raise income tax, national insurance or VAT, senior Whitehall sources said that she and Keir Starmer had begun a series of meetings to thrash out the shape of the budget.
A rise in gambling levies – advocated by the former prime minister Gordon Brown – is thought to be near-guaranteed as part of the package of tax rises.
The pressure facing the government was underlined on Thursday when the Bank of England warned that it could be forced to keep interest rates at higher levels for longer than previously thought as soaring food prices linked to Labour’s tax increases threaten to drive inflation to 4% this year.
The central bank cut interest rates to their lowest level in two years but warned Britain was facing a toxic cocktail of sluggish growth, rising unemployment and stubbornly high inflation.
Reeves and Starmer have held talks over the past weeks to begin to set the parameters of the budget and the economic narrative before Labour’s conference. The government’s limited options were further emphasised this week when the National Institute of Economic and Social Research said “moderate but sustained” tax rises would be needed in the budget for Reeves to overcome a deficit of £41.2bn and restore a near-£10bn buffer.
No date has been set for the budget, which was held last year on 30 October, but government sources expect that it will be in November, giving the chancellor a little longer to roll the pitch for controversial tax rises or cuts – as well as hoped-for improvements in growth.
Advisers believe that a “no surprises” approach will be crucial to prevent negative market reaction. “Last year was a model of how to do it,” one said. “Had we done it otherwise, it would have been a mess.”
Sources pointed towards the early signs Reeves gave to the markets more than a month before her budget last year that she planned to change her fiscal rules around borrowing to invest – and said there would be a similar approach this time.
However, Labour was roundly attacked by business leaders afterwards for failing to warn about a £25bn increase in employer national insurance contributions (NICs), with companies including Tesco and Boots warning that it would raise their costs by £7bn and lead to higher prices and job cuts.
Starmer has spent the week in Chequers meeting key aides and ministers as he begins work on his conference speech. The prime minister is understood to be keen to spend much of the summer thinking about the longer-term major structural problems in the UK economy that the party failed to identify before the election: the sources of low economic growth and productivity.
Strategists also believe that the budget should be a moment to make the argument that Britain must now make serious choices on growth and productivity. They say Starmer must forcefully rebut the charges that the poor state of the economy is down to individual tax and spend choices, but is a sign of the weakness of the economy’s fundamentals.
The budget, they believe, should be a moment to set out the hard road of reforms to tackle those issues.
Reeves and Starmer are understood to have agreed some broad principles for the budget and the Treasury will begin to submit ideas to Downing Street towards the end of the month.
But sources close to Reeves said she is unmoved on her two main pledges – there will be no rise in income tax, national insurance or VAT and no change to the fiscal rules.
One tax rise that is near certain is a change to gambling levies, despite a massive lobbying offensive by the industry. Brown has urged Reeves to spend funds from raising taxes on parts of the gambling industry on lifting the two-child benefit cap, a measure likely to be made even more expensive by higher inflation.
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In one of its closest decisions since its independence more than 25 years ago, the Bank’s monetary policy committee (MPC) voted by 5-4 to cut its key base rate by a quarter point to 4%.
Taking borrowing costs to the lowest level since March 2023, a cut was widely expected in financial markets. However, the decision was a close call, with the rate-setting panel for the first time in history holding two votes before reaching its verdict.
Andrew Bailey, the Bank’s governor, said: “We’ve cut interest rates today, but it was a finely balanced decision. Interest rates are still on a downward path, but any future rate cuts will need to be made gradually and carefully.”
Reeves sought to claim credit for the cut, as she claimed Labour’s economic management had helped Threadneedle Street to reduce borrowing costs five times from a peak of 5.25% in August last year.
“The stability we have brought to the public finances through our plan for change has helped make this possible,” she said.
However, the MPC warned tax-raising measures in the chancellor’s first autumn budget had contributed to the rekindling of inflationary pressures hitting shoppers in the pocket across the country.
Bailey warned that rising inflation could delay further rate cuts in future. “I do think the path continues to be down,” he said. “[But] the path has become more uncertain because of what we’re seeing.”
City investors pared their bets for the timing of future rate cuts, with financial markets expecting a next quarter-point move in February and only one more similar reduction before the end of 2026.
Reeves said reducing child poverty was a priority of the government but did not commit that any money from higher gambling levies would be spent on removing the two-child limit. The child poverty taskforce is expected to be released before the budget this autumn.
“I talk to Gordon [Brown] regularly, and saw him last week when I was in Scotland,” Reeves said on Thursday. “Like Gordon, I am deeply concerned around the levels of child poverty in Britain. No child should grow up hungry or parents not be able to afford the basics for their family.
“On gambling taxes, we’ve already launched a review into gambling taxes. We’re taking evidence on that at the moment, and again, we’ll set out our policies in the normal way, in our budget later this year.”
Inside No 10 and the Treasury there was fury at the predictions of a £51bn hole in Reeves’ budget by the NIESR thinktank, which aides say is impossible to calculate at the moment given that the budget could be another four months away.
But there are fears in other parts of government about how boxed in the government has become, when Reeves has also appeared to rule out a wealth tax. “I am at a loss really how they square the circle,” one Whitehall source said. “It will have to be salami slicing small pieces here and there, when what we should do is bite the bullet.”
At the Bank of England’s press conference on Thursday, the MPC singled out fast-rising food prices as it warned that food price inflation was on track to reach 5.5% before the end of the year. It attributed much of the rise to global factors, including increasingly extreme weather events hitting cocoa and coffee harvests, highlighting the dangers from the climate emergency.
However, it also pointed to “material” rises in employment costs and new charges for recycling packaging, both driven by the government, that were being passed on to shoppers by UK supermarkets.
“In addition to global agricultural commodity prices, domestic labour costs are currently an important driver of food price inflation,” the Bank said.
Business leaders had warned that Reeves’s £25bn increase in employer NICs and a 6.7% rise in the “national living wage” from April would force them to cut jobs and put up prices.
Official figures show unemployment has crept higher in recent months, while the economy shrank in April and May. Inflation has also risen by more than expected, reaching 3.6% in June.