On Thursday, as Sir Keir Starmer denounced Nigel Farage’s “fantasy” economics in a speech in St Helens, Rachel Reeves, the chancellor, was having “final meetings” in London to agree departmental budget settlements ahead of this month’s multi-year spending review, which will set the government’s priorities until 2029.

Labour MPs, who often seem to prefer the luxury beliefs of opposition to the difficult compromises of power, are opposed to spending cuts. The negotiations have been “tortuous”, one minister said. Unprotected budgets – such as the Home Office, justice, housing, environment, local government - are preparing for real terms cuts. And yet factions inside the party want Reeves to tax and spend even more as demonstrated by Angela Rayner’s leaked memo outlining “alternative proposals for raising revenue”.

Reeves and Starmer know how unpopular the government is, and Labour MPs are restive if not yet mutinous. For all their political differences various backbench factions – the soft and hard left, Blue Labour, the 110-strong Growth Group and the Red Wall caucus – are united by their frustration with the prime minister, with his remote, technocratic style and absence of a guiding social and moral philosophy.

Morgan McSweeny, Starmer’s chief of staff – contrary to popular belief he’s not omnipotent but is grappling with an underpowered Downing Street operation – has spoken of having heard “the roar from the electorate about the fundamental crushing of living standards over many years” at the local elections. Another senior party strategist called the Runcorn by-election loss to Reform the party’s “Bien Phu”, after the French defeat to the Viet Minh in the Battle of Dien Bien Phu, in the first Indochina war.

For now, sensing Starmer’s vulnerability and willingness to U-turn, Labour MPs are feeling emboldened. The government is under sustained pressure from the hard and soft left, and from Gordon Brown - who recently guest-edited an issue of the New Statesman dedicated to the scourge of child poverty - to abolish the two-child benefit cap, which would cost £3.5 billion. Brown wants Starmer to govern with greater moral conviction and thinks the abolition of what he calls the “cruel” two-child cap could be funded through a gambling or banking levy.

Reeves accepts that reducing child poverty is a “moral mission” – that phrase has been used a lot in recent days by Labour frontbenchers - but says no final decision has been made on whether to abolish the two-child cap. But confusion and ambiguity remain: Starmer says he wants to “drive down” child poverty but won’t explain when or how he will do it.

Instead, the government will publish a child poverty review, or “taskforce” report, ahead of the Budget in the autumn. “For any policy to address child poverty will have to be fully costed and fully funded,” Reeves said, “because otherwise, you risk undoing the good you’re doing by pushing up the rents and mortgages for ordinary families.”

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In a brilliantly opportunistic speech at the National Liberal Club in London on Tuesday, Farage, a gleeful anti-liberal who boasts of “living rent free” in Starmer’s head, made a pronatalist argument for abolishing the two-child cap: he wants British families to have more children and flourish. Labour strategists feel that they are fighting an “asymmetric war” against Reform: no sooner have they settled on how to combat the anti-system party, then Farage shifts position. He is endlessly protean and is embracing both right and left populism and rather than ignore him Starmer will take him on.

McSweeney, who insists Labour must always put country before party, has long opposed extending benefits such as universal credit to third and subsequent children. So too does Jo White, influential MP for Bassetlaw and chair of the Red Wall caucus. “Lifting the cap would be a retrograde step,” she told me. “The benefit system is there to support people when they’re at their greatest need and should be there throughout life if needed, but the focus has to be on people working and putting a wage on the table and raising aspirations and opportunities through doing that. Having more children is a choice that you should make when the finances allow you to do so. If there’s a system that allows you to keep on having children, then it enables you to remain on benefits for years and years.”

Here then is the faultline in Labour: between realism and hardline progressivism, between the metropolitan liberal-left and the marginalised of peripheral England; those who, as Jo White puts it, “feel done to”, ignored, disrespected, reviled.

All political parties are coalitions, but Starmer leads a party that at some deep, fundamental level is broken. According to More in Common, the party membership is dominated by “progressive activists” who form under 10 per cent of the population.

Is Labour a party of urban progressives, the net zero-supporting, pro-immigration graduate class, or of the working-class labour interest for whom it was founded to represent? Starmer thinks it can be both but the division between those Labour MPs who represent Red Wall seats and the progressive nomenklatura is hardening.

“I hear that some MPs are actually suggesting that we ditch Red Wall areas and focus our energies on holding our vote in the more metropolitan areas,” Jo White said. “That’s one of the divides that Keir Starmer has to respond to. We’re a party that was founded in the 1900s to support the left-behinds, people that have nothing. And what we are about is being the party of equality, raising aspirations, raising opportunities, and where there needs to be state intervention, we take it. And if we don’t do that in Red Wall areas, people will be disconnected from politics and will continue to look for new answers, such as Reform.” She welcomed Starmer’s recent “island of strangers” immigration speech, which enraged the left, and now wants him to hold regular town hall-style meetings in Red Wall areas so that he has a better understanding of the social atmosphere in places far from London.

Lisa Nandy, the culture secretary, recently told me that so widespread is the mood of disaffection in Labour’s old post-industrial heartlands that the north of England “could go up in flames”. One spark could ignite a conflagration comparable to last summer’s riots provoked by the Southport murders.

Reeves is not complacent about the mood in the country or the hostility to her in the party, a legacy of her unilateral decision to scrap the universal pensioners’ winter fuel allowance, which Labour MPs call the party’s “poll tax”.

But when we spoke, she was adamant that the spending review, published on 11 June, would give all colleagues “something to campaign on in every constituency in every part of the country”. Last autumn she relaxed her self-imposed rules on borrowing to allow for increased capital spending and, she points out, consequently has £113 billion to spend on transport, energy and community infrastructure projects.

The benefits of increased investment in infrastructure are generally felt in the long run; Labour, in the here and now, is rapidly losing support as Farage dictates the terms of political debate. McSweeney has rejected the charge that Labour is “overreacting” to the Reform insurgency but believes that, because of the weakness and inertia of the Conservatives – their failure seriously to contest the Runcorn by-election shocked Downing Street - the next election will be a straight contest between Starmer and Farage.

As Farage outlines an erratic programme for government and Reform takes control of councils and mayoralties, and therefore demands greater scrutiny, Reeves remains committed to both her fiscal rules, which prohibit borrowing for day-to-day spending, and pre-general election pledge not to raise income tax, VAT, national insurance (on employees not employers, as it turned out) or corporation tax. “With Nigel Farage, it’s all just fantasy stuff. It will push up bills, it will push up your mortgages, it will push up your taxes in the longer term, because it is all unfunded. The only reason we are back in power today is because we learned the hard way how important it was to be trusted with the public finances.”

She fears the destructive power of the bond market. Her fiscal rules, she said, exist both to reassure (markets) and protect (Labour voters). “I’m not going to take any risks with people’s mortgages. We want to make sure that there is security for working people, but I’ve also got to make sure that we are not inadvertently making working people worse off by having to increase their taxes or borrowing more. We are already borrowing a lot but borrowing more would push up their mortgage rates.”

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Reeves was absent, at a G7 meeting in Canada, when Starmer used last week’s Prime Ministers Questions to announce the government’s U-turn on the pensioners’ winter fuel allowance. The decision was spun by her detractors as a humiliation for Reeves.

“The biggest issue for Rachel is that she’s experienced horrific sexism and misogyny since she got elected to her role,” one MP said. “She’s decided to tackle that by being the Iron Chancellor, which is commendable, but as a consequence of that she’s lost her humanity. The way that she talked about the winter fuel cut was so hard.”

I know Reeves well and in my conversations with her, over many years, I’ve had a clear sense of her political purpose. In opposition, she was Labour’s chancellor-in-waiting but also its chief ideologue, organising seminars with academics such as David Edgerton and Jonathan Rutherford to discuss the fragmentation of globalisation and the “everyday economy”.

But in recent months, as she pursued growth at all costs, cabinet colleagues believe she allowed herself to be captured by Treasury orthodoxy. She was never the most agile public performer, but her pronouncements became ever more stilted and robotic even as she announced ambitious plans to expand Heathrow airport and create a “golden triangle” of innovation, connecting Oxford, Cambridge and London.

Worse still, they believed she was failing to tell a story about the country: she wanted growth but to what end, where and for whom? As one minister put it, “The economics was leading the politics rather than the politics leading the economics. The mantra is growth but not growth everywhere.”

Reeves has listened to criticism. She will use the spending review to correct what a senior aide called the “absolutely false impression” that her priority is growth-powering infrastructure projects in London and the southeast. “The big themes of the review will be around security and renewal in every part of the country,” Reeves told me. “Economic security. Yes. Border security as well. And we will actually show that trajectory to [spending] 2.6 per cent of GDP on defence.”

Increased spending on defence will represent what one strategist described as a direct transfer of cash into every region and every nation of the UK. “That extra money for defence is to protect our country but it also contributes to economic security with more good jobs in places like Rosyth, Plymouth and Barrow, places that aren’t always first in the queue for more money,” Reeves said. “Overall, we’re spending £190 billion more than the plans we inherited from the Tories on day-to-day spending. And £113 billion more on capital spending. So that’s £300 billion more over the course of this parliament.”

Reeves was adamant – against Rayner’s memo - that the government could not borrow or tax more than it is without risking stability and market turbulence; there was the obligatory mention of Liz Truss and her calamitous mini budget. She believes she has got the balance right, which is a direct rebuke to the left.

“I do not think it is a reasonable criticism of this government that we are not spending enough. Look, I get a lot of criticism. A lot of people come up with ideas, but I haven’t heard any serious alternative to what we’re doing. 
We are trying to rebuild the credibility of this country. We are trying to grow the economy, so we’ve got more money to put in people’s pockets and to invest in public services. And you know me, Jason, all my life, I’ve been underestimated, and I’ve fought back against my critics. I will do so again now.”

An equally reasonable criticism is that far from not spending enough the government is already spending and borrowing too much. But too much is never enough for some Labour MPs even though the top 1 per cent of earners already contribute 28 per cent of income tax. As for Starmer, as he ponders how to counter Farage and control, or appease, the forces of unrest inside Labour, he will do whatever he thinks is necessary to retain power and then win again.