Key facts
- UK Chancellor John Healey's fiscal headroom may fall to £12 billion.
- This is down from £23.6 billion at the spring forecast.
- Rising borrowing costs linked to the Iran war have reduced headroom by £9 billion.
- Sluggish growth is expected to cut it by another £2 billion.
- KPMG forecasts UK interest rates will rise to 4% in November.
- Inflation is predicted to peak at 4% in Q1 2027.
UK Chancellor John Healey's fiscal headroom is projected to be significantly reduced by the autumn, potentially leaving him with only about £12 billion, according to a report by KPMG. This figure is down from £23.6 billion at the time of the spring forecast.
The reduction is primarily driven by soaring borrowing costs linked to the ongoing conflict in Iran and a slowdown in economic growth. KPMG estimates that rising borrowing costs on UK debt have already decreased the headroom by approximately £9 billion. An additional £2 billion reduction is anticipated due to sluggish growth and potential downgrades from the Office for Budget Responsibility (OBR).
KPMG stated that the Chancellor will have limited capacity to provide substantial support for economic growth or cost of living measures in the upcoming budget. Restoring the previous level of headroom might necessitate tax increases or spending cuts. Given the government's commitment to not raise taxes on working individuals, alternative tax measures may need to be considered.
Long-term borrowing costs have been escalating amid a sell-off in gilts, fueled by inflation concerns stemming from the Iran war and increasing expectations of interest rate hikes by the end of the year. These combined factors are expected to leave Healey with "limited room for manoeuvre" for his inaugural Budget on October 28.
The group forecasts that UK interest rates will likely increase from 3.75% to 4% in November, before beginning to decline next summer as the impact of energy prices on inflation diminishes. Inflation, which stood at 3.1% in August, is predicted to rise to around 3.5% in the autumn and reach a peak of approximately 4% in the first quarter of next year. KPMG anticipates overall UK growth of 1.3% for 2026, with slower growth in the latter half of the year due to inflation affecting household spending. Growth is projected to edge up to 1.4% in 2027.