Bad news for Chancellor Healey as UK’s financial safety net shrinks to £12 billion
Key Points
- Middle East conflict halved Budget headroom from £24 billion to £12 billion
- Higher debt interest adds around £14 billion a year to borrowing by 2029-30
- Resolution Foundation wants headroom restored to at least £20 billion
- Switching 2p of National Insurance to income tax would raise £6 billion
Conflict in the Middle East has halved the Chancellor’s Budget headroom to £12 billion, the Resolution Foundation said. The think tank published the estimate in Hitting the Buffers, its Budget preview report, on Tuesday (13 October).
Headroom is the amount the Government can borrow before it breaks its own binding fiscal rule, and it stood at £24 billion in the spring.
The UK recorded the fastest growth in the G7 in the first half of 2026, but the conflict has since pushed up borrowing costs and inflation.
The foundation estimated that higher debt interest costs alone will add around £14 billion a year to borrowing by 2029-30.
The Government’s fiscal rules hinge on that year, making the extra cost particularly damaging for Chancellor John Healey.
Higher inflation, wages and equity prices will boost tax revenues and offset some of the extra borrowing, the foundation said. A downward revision to migration figures could add as much as £5 billion more to borrowing, it added.
The foundation wants Healey to rebuild headroom to at least £20 billion at the Budget, as markets scrutinise the public finances of countries around the world.
It said the Government still needs to explain how it will fund new commitments, including the £10 billion required to raise defence spending to 3% of national income.
The foundation said new pledges on teachers’ pay and tackling homelessness should come from within existing public service budgets.
It said savings from disability benefits were possible, but warned that rushed reforms could not arrive in time for the Budget.
The think tank suggested switching 2p of National Insurance onto income tax, which it said would raise £6 billion while protecting working people.
It also called on Healey to set out his tax and spending plans for the rest of the Parliament, including the overall budget and timetable for the 2027 spending review.
“War in the Middle East has likely halved the level of headroom he has against his fiscal rules. And with markets closely scrutinising our fiscal position, he will need to deliver a robust Budget to show he’s serious about sound public finances,” said James Smith, chief economist at the Resolution Foundation.
“But to truly stem uncertainty, the Chancellor needs to reassure financial markets that he is willing to face reality rather than duck it by setting out his approach to tax and spend over the remainder of the Parliament,” said Smith.
The Nuffield Foundation funded the report as part of its research programme into the UK impacts of the US-Iran conflict.
