UK fiscal headroom is set to fall well below the £23.6 billion the Office for Budget Responsibility (OBR) estimated in March, as higher interest-rate and inflation assumptions following the Middle East escalation squeeze the government's room to spend. UBS says higher rate assumptions could cut headroom by around £10 billion, with a further £3 billion at risk from the inflation outlook and additional pressure from migration assumptions and unresolved spending commitments ahead of the Oct. 28 Budget.
UK fiscal headroom is on track to fall well below the £23.6 billion the OBR estimated in March, as higher interest-rate and inflation assumptions following the escalation in the Middle East erode the government's room to spend within its fiscal rules. The March estimate was equivalent to 0.8% of gross domestic product.
Rate and inflation assumptions cut into headroom
That March forecast was finalized before the Middle East conflict escalated, so several of its underlying assumptions, according to UBS: "would look very different today." If the OBR sets its forecast cutoff date around Sept. 2, assumptions for the Bank of England's policy interest rate and 10-year gilt yields would be around 70 basis points higher than in March, which UBS said could reduce fiscal headroom by around £10 billion, or 0.3% of GDP.
A related upward revision to the inflation outlook, bringing it close to the Bank of England's baseline projection of inflation averaging 3% in 2026 and 2.8% in 2027, could cut headroom by a further £3 billion, or 0.1% of GDP, UBS said. Some of this could be offset by stronger tax receipt assumptions.
Migration and spending gaps add further risk
UBS also flagged risks from the OBR's migration and housing assumptions. The OBR's March forecast assumed average net migration of 235,000 a year between 2026 and 2030, above the latest Office for National Statistics figure of 171,000 at the end of 2025. Citing the Institute for Fiscal Studies, UBS said a downgrade to the migration assumption could reduce headroom by a further £4 billion.
Separately, UBS said the government still needs to close a roughly £7 billion, or 0.2% of GDP, funding gap tied to previously announced policies. This includes a reported £4.7 billion shortfall linked to the £15 billion increase in defense spending, plus around £2 billion in combined costs from energy and cost-of-living measures announced under former Prime Minister Keir Starmer and by Andy Burnham.
Limited room to raise revenue
With the Labour government maintaining pledges not to raise income tax, VAT or corporation tax, potential revenue sources are limited, and Chancellor Healey may accept a smaller but still positive headroom, UBS said. The government could also seek greater flexibility within the fiscal rules, including channeling more public investment through public financial institutions such as the British Business Bank and the National Wealth Fund, which would not reduce headroom under the investment rule even as they raise public debt and issuance.
So far, the OBR has not published its forecast timetable ahead of the Oct. 28 Budget. UBS said it would not rule out the OBR moving its cutoff date closer to the Budget, as it did ahead of the 2025 Autumn Budget, given current market volatility.
Source: Investing.com
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