IFS warns Iran-war inflation will force hard Healey Budget choices

IFS projects UK government may need £25bn to keep departmental budgets whole

The Institute for Fiscal Studies has warned that the price spike caused by the US-Israel war against Iran will leave UK Chancellor John Healey facing a choice between spending cuts, tax rises or both when he delivers his first Budget on 28 October, according to BBC News. Higher-than-expected inflation would erode the value of departmental cash budgets, while also pushing up the cost of UK government debt interest payments, the IFS said.

The warning lands as the government faces growing pressure from financial markets over rising borrowing costs, with gilt yields climbing and the chancellor preparing to speak at this week’s annual International Monetary Fund meeting. Healey framed the UK’s response as one of fiscal discipline paired with allied coordination. “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,” Healey said. “But Britain and our allies can face up to these challenges together.” The US-Israel war against Iran and Russia’s invasion of Ukraine have together helped drive up energy prices around the world, with those higher costs passed to customers via higher prices on shelves and at the pumps.

His Budget “will build on this approach with fiscal discipline helping to deliver economic resilience,” he said, and would give households “breathing space.” The IFS expects any such “breathing space” help for households to be temporary and limited in scale. The Treasury declined to comment on “rumour and speculation.”

“A ‘steady-as-she-goes’ Budget is not an option available to the chancellor,” IFS director Helen Miller said. “Choosing to stay the course with the inherited tax and spending plans would mean allowing inflation to blow departments’ spending plans off course.” Simply pencilling in implicit cuts that he has no intention of delivering, she added, “would make the Budget a work of fiction.” The IFS also urged the government to ensure its spending plans are credible, as opposed to proposing unrealistic future cuts to make the Budget add up.

The IFS expects recent gilt-market turbulence and higher inflation to add around £10bn to forecasts for government borrowing costs in 2029-30. Even so, the think tank projects the government will still meet its self-imposed fiscal rules — borrowing only for investment by that financial year and reducing debt as a share of GDP. The cushion against those rules, known as headroom, is likely to fall to about £20bn, down from the £24bn the official forecaster, the Office for Budget Responsibility, predicted at the Spring Statement. Recent indications, the IFS said, suggest markets would be comfortable with that reduced margin.

The think tank estimated that to keep departmental budgets in line with inflation in 2029-30, the government may need to find an extra £25bn — before factoring in any rise in defence spending. Raising such a sum would point to significant tax increases.

Healey is not required to address overall spending totals in the 28 October Budget and could defer the choices until next year’s Spring Statement or Spending Review, when the economic outlook may have shifted. The IFS cautioned that the spending plans inherited from his predecessor, Rachel Reeves, would leave some departments unable to keep pace with inflation within a few years, and that failing to address that would cast doubt on the credibility of the government’s plans.

Earlier chancellors have relied on a similar strategy of pencilling in unrealistic future spending plans to meet fiscal rules on paper and revising them later. The IFS warned that its own forecasts were “exceptionally uncertain” in the current volatile environment and that the OBR’s official forecast, on which the chancellor relies, could come to a very different conclusion.