The ongoing conflict in the Middle East has sharply reduced the fiscal flexibility available to the UK government, with the chancellor’s financial headroom likely halving since the spring, according to a leading economic think tank. The Resolution Foundation warned that the war between the United States and Iran has created a substantial shortfall in public finances, complicating efforts to manage the UK budget amid rising inflation and borrowing costs.

The think tank estimates that Chancellor John Healey’s budgetary headroom, previously around £24 billion earlier this year, may have shrunk to as little as £12 billion ahead of the upcoming budget scheduled for October 28. This contraction is attributed to increased government borrowing costs and higher household expenses for essentials such as food and energy, driven by the economic fallout from the conflict.

Healey is expected to introduce a budget focused on providing a “breathing space” for households and businesses while maintaining fiscal stability amid international uncertainties. The government plans to offer additional support to families grappling with rising energy costs, particularly as energy bills are forecast to surge by approximately 20 percent in January when Ofgem’s new price cap comes into effect. This increase could see average annual household energy bills rise by £360 to around £2,084.

The Resolution Foundation highlighted that debt interest payments have recently escalated, projecting an additional borrowing requirement of around £14 billion per year by 2029-30. However, this increase may be somewhat offset by higher inflation and wage growth, which can boost tax revenues. James Smith, the foundation’s chief economist, stressed the need for the chancellor to balance immediate economic support with restoring confidence in public finances. He noted that “strong economic growth and productivity data” over the summer initially suggested a more optimistic budget outlook, but the war has significantly worsened the fiscal scenario.

Smith emphasized the importance of delivering a budget demonstrating fiscal discipline to reassure financial markets and signalling a clear long-term approach to taxation and spending for the remainder of the parliamentary term. The Resolution Foundation also urged caution against broad, universal energy subsidies. Instead, it recommends a targeted support scheme for vulnerable households, particularly those earning below £24,000 annually. Such a measure could cost about £2 billion but provide average savings of £175 for eligible families, extending beyond the current benefit recipient group.

In contrast, the Institute for Fiscal Studies offered a somewhat more optimistic view, estimating that Healey might retain around £20 billion in budgetary headroom. The IFS pointed to the impact of inflation in raising tax revenues, which could largely offset the increased borrowing costs. Still, it warned that inflation would erode departmental budgets, potentially requiring an additional £12 billion in funding by 2030-31.

As the UK faces rising borrowing costs and domestic inflationary pressures exacerbated by the Middle East conflict, the upcoming budget aims to navigate the dual challenges of supporting households through a cost-of-living squeeze while signaling fiscal responsibility to markets.