Economy sensitive to tax rises after fiscal buffer cut

By the Editorial Team · Thursday, October 29, 2026

The Office for Budget Responsibility has lowered the UK’s fiscal headroom by £7 billion to £15 billion in its latest forecast, citing increased debt servicing costs and risks from geopolitical tensions and inflation. This reduction limits the government’s capacity for future tax cuts or spending increases, even as the economy is projected to grow modestly and achieve a budget surplus by 2029-30.

The UK economy faces increased vulnerability to future tax rises following a reduction in fiscal headroom in the latest budget, according to the Office for Budget Responsibility (OBR). The chancellor’s budget has lowered the fiscal buffer to £15 billion, a decrease of £7 billion from the previous forecast in November, despite the country remaining on track to achieve a budget surplus by 2029-30 as outlined in the current government’s mandate.

The OBR’s forecast highlights a range of risks that could affect public finances, including the ongoing conflict in the Middle East and its implications for energy prices, inflation, and interest rates. Additional uncertainties stem from productivity growth projections, particularly regarding the potential economic impact of artificial intelligence, and the labour market outlook, influenced by unpredictable net migration patterns.

Rising government debt servicing costs have also contributed to the reduced fiscal space, a trend exacerbated since the OBR’s last forecast in March due to the wider geopolitical tensions. Other pressures include elevated departmental expenditures, substantial welfare costs, and increasing tax revenues, with the tax-to-GDP ratio expected to exceed a historic peak of 42.9 percent in 2031-32 and continue rising throughout the forecast period, driven primarily by earlier hikes in national insurance contributions and the freezing of personal tax thresholds.

The OBR cautioned that any unforeseen adverse economic shocks could place significant strain on the UK's fiscal sustainability, especially given that public debt is projected to remain around 95 percent of GDP over the medium term. This is the first set of forecasts to fully incorporate the economic fallout from the recent US-Israeli conflict, which the chancellor identified as a “key driver” behind the need to deploy some of the previously established fiscal headroom.

Despite these challenges, the economy has demonstrated resilience in 2026, with the OBR revising its growth estimate upward to approximately 1.2 percent for the year, compared to 1.1 percent in March. However, growth forecasts for 2027 have been reduced to around 1 percent, reflecting the delayed impact of higher global energy prices and rising interest rates on economic activity. The forecast anticipates a recovery thereafter, with GDP growth expected to reach 1.6 percent in 2028 and hover around 1.7 to 1.8 percent through 2029 and 2030.

Inflation is projected to peak at 3.75 percent in early 2027 before returning to the Bank of England’s target of 2 percent by 2028, assuming a decline in energy prices. The OBR’s central outlook sees the Bank rate rising to approximately 4.25 percent by mid-2027 and exceeding 4.5 percent by the end of the forecast horizon, both higher than earlier projections.

Public sector borrowing is now expected to be higher than previously forecast in every year, driven largely by increased debt interest costs. Borrowing is forecast to decrease gradually from 4.4 percent of GDP in 2025-26 to 1.8 percent by 2030-31.

Market reactions to the revised fiscal headroom have been muted, with a slight decline in yields for ten-year government bonds. Economists suggest investors are focusing more on the government’s broader efforts to reduce the deficit and stabilise debt rather than the reduced fiscal margin itself.

This article was reported by synthesizing coverage from multiple independent news outlets to present a balanced, unbiased account. Read about our editorial standards. Spotted an error? Let us know.