IFS WARNS HEALEY INFLATION IS KEY BUDGET CHALLENGE

The Institute for Fiscal Studies has warned that inflation, not a shrinking fiscal buffer, is the main challenge facing Chancellor John Healey ahead of the Budget on 28 October. The think tank said the war in the Middle East will push inflation higher than expected. However, rising prices will also boost tax revenues, meaning the fall in the Chancellor's headroom should be smaller than widely feared. The IFS said the bigger problem is that inflation will erode departmental budgets, forcing ministers to choose between cuts to public services or extra spending.

According to the IFS, topping up departmental budgets to avoid cuts could cost as much as £35 billion by the end of the decade, requiring tax rises or reduced benefit spending elsewhere. Helen Miller, the IFS director, said the Chancellor "must set out overall spending envelopes that he would be genuinely prepared to live within." The IFS also found that higher interest rates on government debt will add about £10 billion to borrowing in 2029-30. It said this would largely be offset because inflation raises tax revenues by more than it increases benefit spending.

The Office for Budget Responsibility is expected to forecast higher borrowing over the next five years than it projected in March, though still falling and meeting the government's fiscal rules, the IFS said. Under what it called a "plausible scenario," fiscal headroom would stand at around £20 billion in 2029-30, down from the £24 billion forecast in March. The IFS stressed a "very high" degree of uncertainty remains, noting that changes to wage forecasts alone could move headroom by about £10 billion in either direction. Employment, migration and health-related benefit trends will also prove significant, it said.