Rachel Reeves has indicated that the government is considering inflation-busting pay increases for millions of public workers, despite Treasury warnings that such a move could result in an £8 billion fiscal deficit ahead of her first budget this autumn.

Two pay review bodies advising the government have recommended a 5.5% wage rise for 460,000 teachers and 1.4 million NHS staff under the “agenda for change” framework. These recommendations were reportedly submitted to the previous government before the election, but Conservative ministers delayed action until after polling day.

The UK employs eight independent pay review bodies that cover about half of all public servants, including the police, prison service, armed forces, and civil servants. While their recommendations are advisory, they are often implemented. Sources suggest the recommendations for other sectors will likely be similar to those for teachers and NHS staff.

Under former Chancellor Jeremy Hunt, the Treasury conducted private modelling to estimate the cost of implementing these above-inflation pay recommendations. The modelling assumed a 6% increase for agenda for change staff and a 5% rise for other public sector workers. If the Chancellor agrees to these increases, the Treasury’s calculations indicate an additional £8 billion cost to the exchequer.

Reeves hinted at the possibility of following the recommendations during an interview on BBC’s Sunday with Laura Kuenssberg, while ensuring fiscal responsibility. “There is a cost to not settling, a cost of further industrial action, and a cost in terms of the challenge we face recruiting,” she stated.

She criticised the previous Conservative government for delaying tough decisions on pay, singling out former Education Secretary Gillian Keegan for ignoring teacher pay recommendations. Former Chancellor Jeremy Hunt rejected these claims, maintaining that fiscal balance could be achieved without tax increases if Labour reformed the welfare system and controlled public sector pay.

The Resolution Foundation recently warned that the new government faces a potential £12 billion fiscal hole. If Labour decides to protect areas like prisons, police, and local government from fresh cuts, the deficit could swell to £33 billion. Public sector pay rises could exacerbate this issue, forcing Reeves to consider spending cuts or tax increases.

Alternatively, the government could offer lower wage increases, risking a confrontation with trade unions and potential strikes. Currently, ministers are negotiating with junior doctors and rail unions to resolve ongoing disputes.

Bridget Phillipson, the Education Secretary, recently informed teachers that the government could not immediately address the pay recommendation, despite union pressures for action. School leaders have also expressed the need for additional funding to meet these pay recommendations, with a National Governance Association survey revealing that 60% of schools and trusts cannot balance their budgets.

Teaching unions have voted for strike action over pay, arguing that real-term wages have declined since 2010. The National Education Union (NEU) has delayed formal strike action pending the September pay offer. NEU General Secretary Daniel Kebede emphasised the need for substantial pay rises to address recruitment and retention challenges in education.

Nurses continue to dispute pay with the government after a 5% rise was imposed last year. Concerns within Labour highlight that nurses received lower percentage increases compared to consultants and junior doctors, who continued strike action.

A government spokesperson stated, “We value the vital contribution the almost six million public sector workers make to our country. The pay review process is ongoing, and no final decisions have been made. We are under no illusions about the scale of the fiscal inheritance we face.”

During her BBC interview, Reeves also dismissed calls to reconsider the two-child benefit cap, citing its annual cost of over £3 billion.

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Reeves hints at inflation-busting pay rise for public workers amid £8 billion fiscal challenge