The UK's budget gap is widening and markets want to know Reeves' fix

• U.K. Finance Minister Rachel Reeves will deliver her annual Mansion House speech on Tuesday evening.
• The address is a crucial opportunity to signal to the investment community how she will inject growth back into the U.K. economy.
• Investors will be looking for clues on how Reeves plans to fill a black hole in the budget as we approach the Autumn Budget, when next year's fiscal plans are announced.

“I said on day one that economic growth was now our national mission,” U.K. Finance Minister Rachel Reeves said in her first Mansion House speech almost a year ago.

Fast forward to today and investors remain unconvinced, rattled by a slowing economy, muted investment and U.K. government debt that is nearly 100% of gross domestic product (GDP), according to the Office for Budget Responsibility, the government's fiscal watchdog.

Chancellor of the Exchequer Reeves' upcoming Mansion House on Tuesday evening address will be a crucial moment to demonstrate progress and signal the next steps she will take to inject growth back into the U.K. economy.

Investors will be looking for stability and any clues in the speech on how Reeves and the Treasury can fill a potential black hole as they approach the Autumn Budget, when 2026 taxation and spending plans will be laid out.

This year's speech will be more interesting than most, according to George Buckley, Nomura's chief U.K. economist.

“I think because of what's been going on in the public finance and fiscal space, there is going to be a lot more interest in what Ms Reeves has to say. If you look back through previous Mansion House speeches, a lot of them have been talking about things like financial regulation, competition, greening the finance sector,” he noted.

“So if you get a lot of that, there might not be too much interest from the markets. But any suggestion of what might happen in the upcoming budget in the autumn, any discussion of fiscal policy is going to be high on the agenda, and we'll be watching for that very closely,” Buckley added.

There are a some key areas that will be in focus.

Reeves is expected to announce an overhaul of the pensions regime, focusing on the adequacy of retirement savings.

Pensions have become a topical issue for the Labour government since its election win last summer, as rising costs have become a drag on U.K. finances. The OBR forecasts the state pension will cost even more in the future, rising to 7.7% of GDP by the early 2070s.

This is down to an aging population and what's colloquially known as “the triple lock,” where the state pension rises each year in line with either inflation, wage increases or 2.5% — whichever is highest.

But the government has said it is committed to the triple lock during this parliament, which means the savings will need to come from elsewhere.

“There's a lot of pensioners who would be very upset if the triple lock were to be abandoned. I think it's too politically charged to do much about it right now, the government has also said that they won't raise taxes on working people. So they've identified a few taxes they can't do anything about [so] that knocks out about three quarters of your tax take. So they really are hamstrung, I think, in what they can do,” said Buckley.

Many in the City of London fear that Reeves will try to fill a growing hole in her fiscal plans by increasing taxes on the financial services sector, such as an increase in the bank levy, or on wealthy individuals.

“I think a wealth tax is also fairly politically charged. It's something which could potentially raise quite a lot of money, but ... there is a risk that it pushes people out of the country, the brain drain, so to speak, and that's something that they won't want to do,” said Buckley.

The Treasury is also planning to reduce red tape and spur growth by scrapping parts of the senior managers and certification regime, which covers nearly 140,000 finance professionals.

Meanwhile, the chancellor has reportedly shelved any immediate plans to make changes to cash Individual Savings Accounts or ISAs, after strong opposition building societies and consumer campaigners.

And all this comes amid mounting pressure on the chancellor to shore up confidence in her strategy, after a series of U-turns on cuts to welfare and winter fuel payments.