Think Tank Warns Price Spikes Challenge Chancellor Healey's First Budget

Based on reporting by BBC UK:

An influential think tank has issued a warning that the price surge stemming from the US-Israel war in Iran poses a major difficulty for Chancellor John Healey while he compiles his first Budget. The Institute for Fiscal Studies (IFS) stated that inflation exceeding expectations could diminish the amount the government intended to allocate to public services, compelling Healey to select among spending cuts, tax increases, or a combination of both measures. The Treasury declined to comment on what it described as "rumour and speculation."

Ahead of the annual International Monetary Fund meeting, Healey commented that the effects of conflicts in Europe and the Middle East are impacting nations globally, resulting in higher prices at gas stations and more expensive mortgages domestically. He asserted that Britain and its allies could address these challenges collectively, and stated his Budget would build upon this cooperative approach with fiscal discipline to foster economic resilience and provide people with "breathing space."

However, the government faces increasing pressure to demonstrate to financial markets that it maintains firm control over its finances as the cost of borrowing increases. The IFS cautioned Healey against making any spending declarations in the October 28 Budget speech, noting that he has no intention of upholding such commitments. IFS director Helen Miller stated that a "steady-as-she-goes" Budget is not an option for the chancellor. She added that sticking to the inherited tax and spending plans would allow inflation to derail departments' spending plans, and that merely including implicit cuts that he does not intend to implement would render the Budget fictitious.

The US-Israel war against Iran and Russia's invasion of Ukraine have collectively contributed to elevated energy costs worldwide. These increased expenses have been passed on to consumers through higher prices both in stores and at fuel pumps. Furthermore, the wars have contributed to an increase in the cost of UK government debt interest payments, thereby adding to the pressure on Healey.

The IFS noted that while higher inflation will increase tax revenues, it will simultaneously reduce the real value of departments' cash budgets. The IFS anticipates that any "breathing space" assistance provided to households will be temporary and limited in scope.

Regarding borrowing costs, the IFS, similar to other analysts, estimates that recent volatility in bond markets and higher inflation will add approximately £10bn to forecasts for the government's borrowing costs in 2029-30. Nevertheless, the IFS expects the government to satisfy its self-imposed fiscal rules—which mandate borrowing only for investment projects by the financial year 2029-30 and reducing debt as a percentage of GDP—partly due to inflation boosting tax revenues. However, the IFS anticipates these rules will be met with a smaller buffer, or "headroom," of around £20bn, which is less than the £24bn buffer projected by the Office for Budget Responsibility (OBR) during the Spring Statement. Recent market indications suggest comfort with this reduced headroom.

Despite these projections, the IFS estimates that to sustain departmental budgets amid higher inflation, the government might need to secure an additional £25bn in 2029-30, excluding any consideration for increasing defense spending, which would imply substantial tax hikes. The IFS warned that the spending plans inherited from the previous chancellor, Rachel Reeves, would result in some departments' budgets failing to keep pace with inflation in a few years. The IFS stated that failing to address this would undermine the perceived credibility of the government's plans, although previous chancellors have reportedly used a similar tactic of projecting unrealistic future spending plans to meet fiscal rules on the day, only to alter those plans later.