John Healey’s Budget headroom could be cut almost in half by the time he delivers his first Budget on 28 October, as rising borrowing costs driven by the Iran war and slower growth eat into the Government’s financial breathing space, according to new figures from KPMG.
KPMG is a global professional services firm that regularly publishes economic outlooks for the UK. Its latest forecast estimates that the Chancellor could be left with headroom of about £12 billion in the autumn, down from £23.6 billion at the time of the spring forecast. That near-halving leaves Mr Healey with what KPMG describes as “limited room for manoeuvre” when he faces Parliament next month.
How the Iran war is squeezing John Healey’s Budget headroom
The conflict in the Middle East has pushed up borrowing costs on the UK’s debt, cutting about £9 billion off the Government’s fiscal headroom on its own. The remaining reduction, of about £2 billion, is expected to come from sluggish growth and anticipated downgrades from the Office for Budget Responsibility (OBR), the independent body that scrutinises the Government’s finances.
The mechanism behind the borrowing cost surge is worth understanding. Long-term borrowing costs have been rising amid a sell-off in gilts (the bonds the Government issues to fund public spending) driven by inflation worries linked to the conflict and rising expectations that interest rates will increase before the year is out. According to BBC News, the conflict has led to the effective closure of the Strait of Hormuz, a key waterway for oil and gas trade, which has pushed energy costs higher and stoked inflationary pressure across the economy.
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.”
Tax rises or spending cuts: what comes next for the Chancellor?
The firm’s assessment is blunt about what restoring the previous level of headroom would require. “Restoring the previous level of headroom could require tax rises or spending reductions,” KPMG said. “With the Government committed to not increasing taxes on working people, the Chancellor may need to consider other tax measures.”
According to The Independent, the Budget on 28 October will be Mr Healey’s first since being appointed Chancellor by Andy Burnham in July, making it a significant early test of the new administration’s economic credibility.
KPMG is predicting that UK interest rates will likely rise in November, from 3.75% to 4%, before starting to fall back next summer as the impact of energy prices on inflation fades. The group forecasts that inflation, which rose to 3.1% in August, will climb to about 3.5% in the autumn and peak at about 4% in the first quarter of next year.
On growth, KPMG is pencilling in an overall rate of 1.3% for 2026, but with a softer second half as inflation weighs on household spending. Growth is then expected to edge up to 1.4% the following year. That picture of modest but slowing expansion gives little comfort to a Chancellor already facing pressure on borrowing costs.
The combination of factors, higher inflation, rising rates, a conflict-driven energy shock and a constrained OBR forecast, means Mr Healey arrives at his inaugural Budget with far less room to manoeuvre than his predecessor had in the spring. With the 28 October date now firm, the question of which taxes or budgets might move is likely to dominate political debate in the weeks ahead.
