The UK faces 'very difficult trade-offs' in the next autumn budget if the Iran war continues to drive up oil prices and inflation, according to the National Institute of Economic and Social Research (NIESR). The leading thinktank warned Prime Minister Andy Burnham that his plans to revamp public services would come under severe pressure from persistently higher prices.
With oil prices briefly rising above $100 a barrel and the Strait of Hormuz effectively closed since March, NIESR expects inflation to reach 3.8% within seven months. This would force Chancellor John Healey to find an additional £24bn by the end of the decade to maintain services and real-terms welfare payments.
Budget headroom slashed
NIESR cut its forecast for the chancellor's spending headroom in the budget from just over £7bn to nearly £3bn. In March, the Office for Budget Responsibility estimated the Treasury had about £22bn of spare capacity above existing spending commitments.
The thinktank said the UK 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 rate next year, meaning the UK will lose £28bn in growth over two years compared with January forecasts.
Challenging inheritance
David Aikman, NIESR's director, said Burnham faced 'a challenging inheritance' with spending 'eroded by inflation', the highest borrowing costs in the G7, new spending demands, and cost-of-living pressures. He warned against easing the strain by raising borrowing, calling it a mistake that would cause future strife.
'New commitments on defence or household support should be funded through taxation or savings elsewhere, not through further borrowing,' Aikman said. 'Rebuilding the capacity to absorb future shocks will require a determined attempt to bring debt down.'
Policy pledges and debt concerns
Since becoming PM, Burnham pledged to improve adult social care, with an estimated £18.5bn bill for an NHS-style system free at point of use by 2035. He also singled out 1 million young people not in education, employment or training (Neets) for support, including mental health services and education revamp.
NIESR said total government debt, nearly £3tn or 95% of annual national income, would likely rise if the chancellor used borrowing to boost spending. The institute has been one of the gloomier forecasters, predicting significant shocks that proved more muted.
Economic outlook and inflation
Stephen Millard, head of macroeconomic forecasting, said the UK economy proved 'surprisingly resilient' in early 2025 but a slowdown is still expected. He added: 'Even if peace is restored quickly in the Middle East, inflation will still rise and the new chancellor will need to make difficult decisions on funding policy announcements, from VAT cuts on electricity to the £2 bus fare cap.'
Millard supported a land value tax to replace council tax and stamp duty, and phasing out VAT exemptions on energy and children's clothes. He also urged tackling tax avoidance by wealthy individuals and companies.
NIESR expects inflation to average 3.1% in 2026, peaking at 3.8% in February 2027 after energy price cap adjustments, and not returning to the Bank of England's 2% target until early 2029. Bank of England officials meet Thursday, with markets expecting rates to hold before rising to 4% later in the year.
