B-Day saw no declaration of a truce between Blair and Brown

When he was Chancellor, Kenneth Clarke once observed that Budgets ecstatically received in the immediate aftermath were nearly always judged to have been a disaster a few months later. I offer a variation on this theme. Budgets received with indifference the day after delivery are much more significant than they really seem.

Last week's Budget was met with near-silence, fit only for the inside pages of newspapers and brief reports on television. What a contrast to some of Gordon Brown's earlier Budgets when my theory applied in reverse: tiny incremental proposals were trumpeted over the front pages for days as if a revolution were taking place – a prudent revolution. The indifference to Brown's latest address was largely due to the war, but even those assigned the task of reporting the Budget commented on how thin it was, no more than a holding statement. I disagree.

There were few precise policy announcements, but in political terms this was a pivotal speech, outlining a domestic agenda for the Government for the next few years. Like the causes of the war, the Government's domestic agenda tends to change with such regularity that it is normally quite hard to pinpoint the values and principles that give it direction. So a meaty political speech with a clear agenda is an important novelty in itself, especially after a war that has left many ministers, MPs and Labour Party members wondering what it is they stand for.

Most immediately, the Budget should end the absurd fantasy that Brown is an old Labour figure blocking Blair's modernising instincts. Brown is New Labour to the end of his fingertips. Last week's speech contained all the familiar juxtapositions, with "flexibility and fairness" recurring more than once. Typically, Brown hailed the success of policies in the United States that encourage "innovation and enterprise". Most cheekily of all, he said that it was now "prudent to borrow", echoing earlier New Labour Budgets when he prudently repaid debt. When prudence stepped off the stage for a few sentences, he spoke of the need to be "vigilant to risk" – prudence in disguise.

So no surprises, then: New Labour is alive and kicking in the Treasury. Except that in the current febrile climate within the Government it should come as a whopping great surprise. Brown has suffered one of the more dismal phases of his political career with Cabinet colleagues, or colleagues of Cabinet colleagues, briefing to receptive journalists that he is a stubborn old Labour figure standing in the way of their bold modernising adventure. A perverse myth has developed that old Labour Brown has become New Labour's biggest barrier to progress.

In reality, he has been plotting the next phase for New Labour, working late into the night for several months on two densely argued lectures (there is a third to come) and the Budget itself. In the first lecture he examined the role of markets and the reasons why, with some important qualifications, left-of-centre governments should enthuse about them. Most recently he has delivered another 8,000 words on the importance of flexible labour markets. These lectures were largely ignored, partly because of the war, but I predict they will form the basis of the Government's thinking over the next few years and, to some extent, they are already doing so. Last week's Budget was sprinkled with schemes – some of them will be highly controversial – to encourage more flexible labour and, equally important, more highly skilled labour. Markets and labour flexibility: this is not an old Labour agenda.

The crude categorisation has come about because the dynamics of the Cabinet have changed in the second term. During the first term the tensions between Blair and Brown were over generalities; they were more of a soap opera than anything else. Blair and his entourage despaired of what they regarded as Brown's erratic loyalty. The Prime Minister felt that he had delivered all that he could have done for Brown – including an unprecedented influence over policy, extending well beyond the economy – and that Brown was still being awkward and ungrateful.

The Chancellor was disdainful of Blair's fluctuating priorities. Early on, his entourage hid their stealth taxes, partly so that the Prime Minister would not notice them. Blair wanted taxes to come down, but suddenly he became obsessed with the need to increase public spending, asking Brown to provide more for the NHS in particular. "He wants me to cut taxes and increase public spending," the Chancellor would despairingly observe.

These tensions were manageable because the two of them were learning to govern together after 18 years of opposition. They agreed on the broad direction and more or less accepted the dynamics of the relationship that Brown would be given unprecedented leverage, but Blair as Prime Minister would inevitably have the final say.

The danger now is that the tensions are over precise emblematic policies. There was a mischievously provocative section in the Budget. After announcing concessions for elderly pensioners who have lengthy hospital treatments, Brown stated: "To those opposite who have advocated vouchers, fees, new health charges for medical services or basic accommodation, this is the Government's answer: we have not only rejected these charges, but are abolishing the hospital accommodation charges."

This was a highly significant political moment. Those seemingly innocent words were not only aimed at "those opposite". To Brown's alarm, Blair has written of the need to introduce "co-payments" in public services. The Health Secretary, Alan Milburn, wants foundation hospitals to borrow in a way that means they might have to charge fees in order to repay their loans. Brown was speaking to those sitting near him on his own front bench, as well on the Opposition benches. His agenda for the public services envisages a different set of reforms, including the long overdue end of national pay bargaining – necessary, fair, logical and a proposal that will involve a big and very New Labour row with the unions.

So the Chancellor offers a slight variation on the New Labour narrative: investment and reform in the public services, excluding "co-payments", some stealthy devolution, flexible and better-trained labour markets, a stable housing market, partly to prepare for entry into the euro in the third term. The Budget may have been policy-free, but the policy implications for the future are huge.

Although Brown is sometimes too cautious about the radical possibilities for a landslide government, there is no one else in the Cabinet who attempts to match values with coherent policies in quite the same way. Blair says vaguely that his actions are based on "what I judge to be right"; ultra-Blairites speak of the need to "keep on moving forward", which does not get us very far. On the other hand, the old left throws grenades without offering a coherent alternative of its own.

When there is a vacancy for his party's leadership, Brown will be the New Labour candidate. His only worry should be whether New Labour will still be in fashion when the time comes.