UK inflation surge opens £35bn hole in spending plans, IFS warns

Chancellor John Healey is facing a funding gap of up to £35bn, according to calculations published this morning by the Institute for Fiscal Studies (IFS). The figure lands as the UK's inflation pressures sit at a three-year high.

The IFS attributes the shortfall to the surge in inflation that followed the start of the Iran war. That price shock has done damage on two fronts, the fiscal think tank said.

First, rising inflation has eroded the real value of cash budgets allocated to government departments. Money set aside before the price surge now buys less, forcing departments to stretch fixed allocations across higher costs.

Second, inflation has driven up government borrowing costs. Higher prices have pushed up the interest rates the UK must pay when it raises debt, compounding the pressure on the public finances.

The IFS delivered its warning on the morning of October 12, in rolling coverage that also tracks the day's award of the Nobel memorial prize in economics — an event that will sharpen attention on the fiscal and monetary policy debate now confronting Westminster.

What does the £35bn gap mean for the chancellor?

The scale of the figure matters. At up to £35bn, the funding gap approaches the size of major fiscal events in recent budgets. It leaves Healey with a choice: find new money, cut departmental plans, or borrow at the very moment borrowing costs are rising.

The inflation backdrop constrains all three routes. Price growth running at its fastest in three years limits room for extra spending without adding to demand, while dearer gilt issuance makes debt-funded solutions more expensive than they were when the budgets were set.

Why did the Iran war hit UK budgets?

The conflict's start triggered the inflation surge, the IFS said. The transmission ran through the wider economy — higher prices fed into departmental costs and into the government's own debt-servicing bill, hitting the fiscal position from both directions at once.

The result is a squeeze that was not on the books when spending plans were drawn up.

What comes next?

With inflation at a three-year high and the funding gap now quantified at up to £35bn, the pressure shifts to the Treasury's next fiscal statement. How Healey closes the gap — and at what cost to departmental budgets — will set the terms of the UK's economic debate in the weeks ahead.