Iran war threatens Healey's Budget plans, think tank warns

Iran war threatens Healey's Budget plans, think tank warns

The price surge triggered by the US-Israel war in Iran presents a major test for Chancellor John Healey as he prepares his first Budget, an influential think tank has warned.

The Institute for Fiscal Studies (IFS) said inflation coming in higher than expected could reduce the amount the government had planned to spend on public services, forcing Healey to decide between spending cuts, tax rises, or a combination of the two.

It called on the government to make sure its spending plans are believable, rather than setting out unrealistic future cuts simply to make the Budget balance.

The Treasury declined to comment on "rumour and speculation".

But speaking before this week’s annual International Monetary Fund meeting, Healey said: "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."

He said his Budget "will build on this approach with fiscal discipline helping to deliver economic resilience" and provide people with "breathing space".

Even so, the government is facing increasing pressure to convince financial markets that it has a firm hold on the public finances as borrowing costs rise.

The IFS warned Healey against making any spending promises in the 28 October Budget speech that he has no intention of keeping.

"A 'steady-as-she-goes' Budget is not an option available to the chancellor," said 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 would make the Budget a work of fiction," she added.

The US-Israel war against Iran and Russia's invasion of Ukraine have together helped push up energy prices globally.

Those higher costs have been passed on to consumers through more expensive goods on shelves and higher prices at the pumps.

The wars have also helped drive up the cost of UK government debt interest payments, adding to the pressure on Healey.

While higher inflation would increase tax receipts, the IFS said it would also reduce the real value of departments' cash budgets.

Like other analysts, the IFS believes recent bond market turbulence and higher inflation will add about £10bn to forecasts for the government's borrowing costs in 2029-30.

Even so, it still expects the government to meet its self-imposed fiscal rules - that it will only borrow for investment projects by the financial year 2029-30 and also be reducing debt as a percentage of GDP - not least because inflation lifts tax revenues.

But it expects those rules to be met with a smaller buffer - known as "headroom" - of around £20bn. That is below the £24bn buffer forecast at the time of the Spring Statement by the official forecaster, the Office for Budget Responsibility (OBR).

Recent signs have suggested markets would be comfortable with that level of reduced headroom. The IFS also expects any "breathing space" support for households to be temporary and limited in size.

However, the IFS warns that in such a volatile environment, its forecasts are exceptionally uncertain. And the official forecast from the OBR - which the chancellor relies on when making his plans - may reach a very different conclusion.

The IFS estimates that, to keep departments' budgets steady in the face of higher inflation, the government may need to find an extra £25bn in 2029-30.

That is before considering the ambition to increase defence spending. Raising that amount would point to significant tax rises.

The chancellor does not have to set out spending totals in this Budget, and may decide to leave such choices until later events - for example, next year's Spring Statement or Spending Review - by which time the economic outlook could be very different.

But the IFS warned that the spending plans inherited from the previous chancellor, Rachel Reeves, would mean some departments' budgets would fail to keep pace with inflation in a few years' time.

It said failing to deal with this would undermine confidence in the credibility of the government's plans.

However, previous chancellors have used a similar approach of pencilling in unrealistic future spending plans to ensure they meet the fiscal rules on the day - only to revise the plans later on.