UK budget watchdog to factor stickier inflation into fiscal forecasts

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UK budget watchdog updates forecast

Highlights

Office for Budget Responsibility will update fiscal forecasts by factoring in stickier inflation and lessons from the post-2022 energy price surge.
The previous March 3 OBR projections gave Rachel Reeves a 24 billion pounds buffer, but recent inflationary pressures and geopolitical risks may erode this headroom.
Recent experience of higher-than-expected inflation, public spending, and debt since 2022 shapes OBR's current approach, with Reeves ruling out a return to universal energy subsidies.

Forecast update reshapes budget headroom

As reported by Reuters, the Office for Budget Responsibility says it will incorporate lessons from the post-2022 energy price surge when it prepares new forecasts for finance minister Rachel Reeves' annual budget later this year. The watchdog says it has adjusted its analytical and modelling toolkit, including assumptions on how energy prices feed through into inflation and parts of its short-term inflation modelling.

The OBR's forecasts are closely watched because they help determine how much room British governments have for public spending while still meeting fiscal rules. Its last projections, published on March 3, showed Reeves had a modest 24 billion pounds of headroom to achieve her goal of balancing the current budget, excluding investment spending, by 2029-30.

The latest comments indicate that buffer could come under greater pressure than some analysts expect. The previous forecasts did not account for the Iran war, which started on February 28, and whose effects have prompted the Bank of England to project higher inflation and weaker economic growth.

Inflation risks and policy implications

The OBR says the last major energy shock, following Russia's full-scale invasion of Ukraine in 2022, led to higher inflation, stronger public spending and more government borrowing and debt than it had anticipated at the time and in subsequent years. That experience now appears to be shaping how it assesses the current inflation backdrop and the fiscal risks tied to it.

Reeves says she does not plan to repeat the costly universal energy subsidies introduced under the Conservative government in 2022. The Bank of England also says there are reasons inflation may prove less persistent this time, including more slack in the economy and a smaller rise in natural gas prices.

Our earlier article on the European Commission’s proposed temporary fiscal cushion for energy costs explained how Brussels is considering letting member states exclude limited emergency energy support from EU deficit limits as prices rise amid the Middle East conflict. We noted the plan would allow up to 0.3% of GDP in energy-related spending to sit outside the bloc’s fiscal cap, aiming to give governments short-term room to protect households and businesses without triggering deficit procedures.

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