Iran conflict threatens UK Budget stability, IFS warns

The ongoing conflict between the US, Israel, and Iran is creating a significant hurdle for Chancellor John Healey as he prepares his first Budget, according to a warning from the Institute for Fiscal Studies (IFS). The think tank cautioned that inflation rising above expectations could erode the funds the government intended to allocate to public services.

IFS director Helen Miller stated that a “steady-as-she-goes” approach is no longer viable. She argued that adhering strictly to inherited tax and spending plans would allow inflation to disrupt departmental budgets. Instead, the IFS urged the government to avoid listing spending cuts in the 28 October Budget speech that it does not intend to implement, describing such tactics as creating a “work of fiction” rather than a credible financial plan.

Healey addressed the global instability ahead of the annual International Monetary Fund meeting, noting that conflicts in the Middle East and Europe are driving up prices at petrol pumps and increasing mortgage costs. He emphasized that Britain and its allies are confronting these challenges together and that his Budget will prioritize fiscal discipline to build economic resilience.

The surge in energy prices, exacerbated by the war in Iran and Russia’s invasion of Ukraine, has led to higher costs for consumers and increased interest payments on UK government debt. While higher inflation boosts tax revenues, it simultaneously reduces the real value of cash budgets for government departments. The IFS estimates that bond market turbulence and inflation could add approximately £10bn to borrowing cost forecasts for the 2029-30 financial year.

Although the government is still expected to meet its self-imposed fiscal rules—borrowing only for investment by 2029-30 and reducing debt as a percentage of GDP—the margin of safety, or “headroom,” is projected to shrink to around £20bn. This is lower than the £24bn buffer forecasted during the Spring Statement by the Office for Budget Responsibility (OBR).

The IFS noted that maintaining current department budgets amidst rising inflation may require finding an additional £25bn by 2029-30, excluding any increases in defence spending. Such a sum would likely necessitate substantial tax rises. While Healey could defer detailed spending decisions to next year’s Spring Statement or Spending Review, the IFS warned that ignoring the gap between inherited plans and inflation would undermine the credibility of the government’s financial strategy.

The Treasury declined to comment on what it termed “rumour and speculation.” However, the IFS highlighted that official forecasts from the OBR may differ significantly from their own due to the volatile economic environment, adding further uncertainty to the Chancellor’s planning.