Energy price spikes triggered by conflict in Iran pose a major challenge for Chancellor John Healey as he prepares his first Budget on 28 October, according to the Institute for Fiscal Studies. The influential think tank warned that higher-than-expected inflation could reduce the amount available for public services, forcing difficult choices between spending cuts, tax rises or a combination of the two. The wars in the Middle East and Ukraine have driven up energy prices globally, pushing up costs for UK consumers and increasing the government's debt interest payments.
The inflation surge will boost tax revenues but will also eat into the value of departments' cash budgets, the IFS said. The think tank estimates the government may need to find an extra £25bn in 2029-30 just to maintain departments' budgets in line with inflation, before considering plans to raise defence spending. This points to potentially significant tax rises.
The IFS expects higher inflation and bond market turbulence to add around £10bn to forecasts for government borrowing costs in 2029-30. The government's fiscal headroom is forecast to shrink to around £20bn, down from £24bn predicted by the Office for Budget Responsibility at the Spring Statement. Despite this, the IFS still expects the government to meet its self-imposed fiscal rules.
The IFS urged Healey to ensure spending plans are credible rather than pencilling in unrealistic future cuts. Director Helen Miller said: "Simply pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction." However, the think tank warned that forecasts in such a volatile environment remain exceptionally uncertain.