The price spike caused by the US-Israel war in Iran poses a significant challenge for Chancellor John Healey as he prepares his first Budget, according to the Institute for Fiscal Studies (IFS). Higher-than-expected inflation could reduce the government's planned spending on public services, leading Healey to consider spending cuts, tax increases, or a combination of both. The IFS urged the government to ensure its spending plans are credible rather than proposing unrealistic future cuts to balance the Budget.
The Treasury declined to comment on what it termed "rumour and speculation." Ahead of the annual International Monetary Fund meeting, Healey stated, "The consequences of conflict in the Middle East and Europe are hitting countries worldwide, leading to higher prices at the pumps and more expensive mortgages at home. But Britain and our allies can face up to these challenges together."
Healey emphasized that his Budget would focus on fiscal discipline to enhance economic resilience and provide financial relief to citizens. However, there is increasing pressure on the government to demonstrate control over finances as borrowing costs rise.
The IFS cautioned Healey against making spending announcements in the 28 October Budget speech that he does not intend to honor. IFS director Helen Miller stated, "A 'steady-as-she-goes' Budget is not an option available to the chancellor," adding that maintaining inherited tax and spending plans could allow inflation to disrupt departmental budgets.
The ongoing US-Israel war and Russia's invasion of Ukraine have contributed to rising global energy prices, which have been passed on to consumers through increased prices for goods and fuel. These conflicts have also raised the cost of UK government debt interest payments, adding further pressure on Healey.
While higher inflation may increase tax revenues, it will also diminish the value of departmental cash budgets, according to the IFS. The organization estimates that recent market turbulence and inflation will add approximately £10 billion to the government's borrowing forecasts for 2029-30.
Despite these challenges, the IFS expects the government to adhere to its fiscal rules, which stipulate borrowing only for investment projects by the financial year 2029-30 and a reduction in debt as a percentage of GDP. However, it anticipates a smaller buffer of around £20 billion, down from the £24 billion predicted during the Spring Statement by the Office for Budget Responsibility (OBR).
The IFS believes that markets would be comfortable with this reduced headroom, but any financial relief for households is expected to be temporary and limited in scale. The IFS also warns that its forecasts are exceptionally uncertain in the current volatile environment, and the OBR's official forecast, which the chancellor relies on for planning, may yield different conclusions.
To maintain departmental budgets amid rising inflation, the government may need to identify an additional £25 billion by 2029-30, especially considering plans to increase defense spending. Achieving this would likely necessitate significant tax increases.
The chancellor is not required to address spending totals in this Budget and may defer such decisions until future events, such as next year's Spring Statement or Spending Review, when the economic outlook may change. However, the IFS cautioned that the spending plans inherited from former chancellor Rachel Reeves could result in some departmental budgets failing to keep pace with inflation in the coming years, undermining the credibility of the government's plans. Previous chancellors have employed similar strategies of proposing unrealistic future spending plans to meet fiscal rules, only to revise them later.