The National Institute of Economic and Social Research (NIESR) has warned that the Iran war will force "very difficult trade-offs in the next autumn budget" if oil prices and inflation remain high. The thinktank said Prime Minister Andy Burnham faced a "challenging inheritance" and his plans to revamp public services would meet severe pressure from persistently higher prices.
Economic forecasts cut as oil tops $100
With oil prices briefly above $100 a barrel and the Strait of Hormuz all but closed since March, the NIESR expects inflation to rise to 3.8% over the next seven months. This would force Chancellor John Healey to find an extra £24bn by the end of the decade to maintain services and real-terms welfare payments. The thinktank cut its forecast for the chancellor's spending headroom in the budget from just over £7bn to nearer £3bn. The Office for Budget Responsibility had estimated in March that the Treasury had about £22bn of spare capacity above existing spending commitments.
Slower growth and lost output
The NIESR said the economy would grow at a slower pace this year and in 2027 due to higher energy prices and uncertainty from the on-off war. Growth is downgraded to 1.1% this year and the same pace next year, meaning the UK would suffer £28bn in lost growth over two years compared with January forecasts.
David Aikman, the institute's director, said Burnham faced "a challenging inheritance" with spending "eroded by inflation", coupled with the highest borrowing costs in the G7, new spending demands and cost-of-living pressures. He warned against easing the strain by raising borrowing, saying it would cause further strife later, especially during another health or economic shock. Aikman added: "New commitments on defence or household support should be funded through taxation or savings elsewhere, not through further borrowing. Rebuilding the capacity to absorb future shocks will require a determined attempt to bring debt down."
Policy pledges and debt concerns
Since becoming PM last week, Burnham has pledged to improve adult social care, with an estimated £18.5bn bill for providing an NHS-style system free at the point of use by 2035. He also singled out support for the 1 million young people classed as Neets (not in education, employment or training), with more extensive mental health services and an education system revamp. The NIESR said total government debt, almost £3tn or 95% of annual national income, would likely rise again if the chancellor used borrowing to boost spending.
Inflation and interest rate outlook
Stephen Millard, head of macroeconomic forecasting at the NIESR, said the UK economy had been "surprisingly resilient" in the first half of this year "but a slowdown is still to come". He added: "Even if peace is restored relatively quickly in the Middle East, inflation will still rise and the new chancellor will need to make some difficult decisions with respect to how to fund the latest policy announcements, from cuts to VAT on electricity and business rates for pubs, to the £2 bus fare cap." Millard supported introducing a land value tax to replace council tax and stamp duty on home sales, and phasing out exemptions and discounts affecting VAT, including those on energy and children's clothes. He also said there was scope to tackle tax avoidance by wealthy individuals and companies.
The NIESR expects inflation to average 3.1% in 2026, peaking at 3.8% in February 2027 after energy price cap adjustments, and taking until early 2029 to fall back to the Bank of England's 2% target, later than previously forecast. Bank of England officials meet on Thursday, with financial markets expecting them to hold rates steady before raising them to 4% later in the year.
