Chancellor’s headroom ‘to halve because of Iran war inflation and weak growth’

Chancellor John Healey will face pressure to raise taxes or cut spending at next month’s Budget, as soaring borrowing costs because of the Iran war and weaker growth has wiped nearly £12 billion off the Government’s fiscal headroom, according to a new report.

The latest KPMG economic outlook estimates that Mr Healey could be left with headroom of about £12 billion in the autumn, down from £23.6 billion at the time of the spring forecast.

It said rising borrowing costs on the UK’s debt after the Middle East conflict has already cut about £9 billion off the headroom, with sluggish growth and expected downgrades from the Office for Budget Responsibility (OBR) likely to to reduce it by about another £2 billion.

KPMG said: “The Chancellor will have limited scope to provide significant support for growth or the cost of living when the Budget is delivered next month, as higher borrowing costs and weaker growth have reduced the Government’s fiscal headroom.

“Restoring the previous level of headroom could require tax rises or spending reductions.

“With the Government committed to not increasing taxes on working people, the Chancellor may need to consider other tax measures.”

Long-term borrowing costs have been surging amid a gilt sell-off driven by inflation worries caused by the Iran war and rising expectations of a rise in interest rates by the year end.

These factors will combine to leave Mr Healey with “limited room for manoeuvre” at his October 28 inaugural Budget, KPMG said.

The group is predicting UK interest rates will likely rise in November, from 3.75% to 4%, but then start falling back next summer as the impact of energy prices on inflation fades away.

It is forecasting inflation, which rose to 3.1% in August, will rise to about 3.5% in the autumn and peak at about 4% in the first quarter of next year.

KPMG is pencilling in growth of 1.3% overall in 2026, but with slower growth in the final six months as inflation weighs on household spending.

Growth will edge up to 1.4% next year, according to the group.