The price spike caused by the US-Israel war in Iran poses a major challenge for Chancellor John Healey as he puts together his first Budget, an influential think tank has warned.
Higher-than-expected inflation could eat into what the government hoped to spend on public services, meaning Healey will have to choose between spending cuts, tax rises, or a mixture of both, the Institute for Fiscal Studies (IFS) said.
It urged the government to ensure its spending plans are credible, as opposed to proposing unrealistic future cuts to make the Budget add up.
The Treasury declined to comment on “rumour and speculation”.
However, speaking ahead of the annual International Monetary Fund meeting this week, Healey said: “The consequences of conflict in the Middle East and Europe are hitting countries worldwide, leading to higher prices at the pumps and more expensive mortgages at home.
“But Britain and our allies can face up to these challenges together.”
He said his Budget “will build on this approach with fiscal discipline helping to deliver economic resilience” and give people “breathing space”.
However, the government is under growing pressure to show financial markets that it has a tight grip on finances as the cost of borrowing rises.
The IFS cautioned Healey about making any spending announcements in the 28 October Budget speech he has no intention of honouring.
“A ‘steady-as-she-goes’ Budget is not an option available to the chancellor,” said IFS director Helen Miller said.
“Choosing to stay the course with the inherited tax and spending plans would mean allowing inflation to blow departments’ spending plans off course.
“Simply pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction,” she added.
The US-Israel war against Iran and Russia’s invasion of Ukraine have together helped drive up energy prices around the world.
These higher costs have been passed to customers via higher prices on shelves and at the pumps.
The wars have also contributed to a rise in the cost of UK government debt interest payments, adding to the pressure on Healey.
Although higher inflation will boost tax revenues, it will also eat into the value of departments’ cash budgets, the IFS said.