A prominent policy research body has warned Chancellor John Healey that fuel costs driven upward by the military confrontation between the US-Israel alliance and Iran may complicate the economic assumptions underpinning his first Budget. Inflation running above forecast levels could compress the fiscal headroom the government had set aside for public services, leaving Healey facing a choice among spending reductions, tax increases, or some blend of the two, according to the Institute for Fiscal Studies.

The body called on the government to ground its fiscal plans in realistic projections, rather than relying on future spending reductions that may prove difficult to deliver in practice. A Treasury spokesperson offered no response to questions framed around unverified reports and conjecture.

At the annual IMF gathering that week, Healey put forward the case that ongoing armed conflicts in the Middle East and Europe were placing upward pressure on living costs globally, pointing to fuel prices and mortgage rates as two areas bearing the burden. He added that the forthcoming Budget would extend that approach, with sound public finances underpinning economic resilience and providing people with room to recover, while Britain and its partners could address those pressures in concert.

Borrowing costs have been climbing, and financial markets are watching to see whether the government can demonstrate it holds public spending firmly in check. The IFS put the chancellor on notice that spending commitments made in the 28 October Budget speech reflect genuine intent, with IFS director Helen Miller stating that holding to the inherited tax and spending plans was not a viable path forward, given that inflation would erode departmental budgets if the government chose simply to maintain the existing course.

Miller's argument held that any Budget resting on spending cuts treated as foregone conclusions — assumed in silence rather than pledged in public — would fall well short of a credible fiscal plan.

Global energy prices have faced upward pressure from two overlapping conflicts: fighting between Israel and Iran, and Russia's military campaign in Ukraine. Higher costs along the supply chain found their way into the prices shoppers encountered at checkouts and drivers faced when pulling up to fill their tanks. Conflict-driven increases in borrowing costs have pushed up the interest burden on UK government debt, adding to the fiscal pressures bearing down on Healey.

The IFS noted that while elevated inflation would lift tax receipts, it would simultaneously erode the purchasing power of departmental cash budgets. Bond market volatility and elevated inflation are expected by the IFS — a view described as shared across the analyst community — to push the government's borrowing costs some £10bn above earlier projections by 2029-30.

The expectation remains that the government will adhere to its own fiscal targets — borrowing confined to investment purposes by the 2029-30 financial year, alongside a declining debt-to-GDP ratio — a position underpinned partly by the upward pressure that inflation places on tax receipts. That figure is anticipated to leave a cushion — referred to in fiscal terms as "headroom" — of approximately £20bn against those requirements.

At the time of the Spring Statement, the Office for Budget Responsibility — the government's official forecaster — had put the fiscal buffer at £24bn, a figure that stands above the current level. Market signals at the time pointed toward tolerance for a fiscal buffer of that reduced scale.

The IFS anticipates that any household relief of this kind would be short-term and modest in scope. The IFS has noted that its projections carry an unusually high degree of uncertainty given the current instability in conditions. The OBR's independent projections, which feed directly into the chancellor's budgetary planning, may point in a different direction when they are published.

According to IFS projections, keeping departmental budgets protected against rising inflation could require the government to locate around £25bn in additional funding by 2029-30. Plans to increase defence spending add yet another layer to the fiscal pressures already in play. Generating that volume of revenue would, according to the IFS, in all probability depend on raising taxes to one degree or another.

Spending totals are not among the items the chancellor is obliged to address in this Budget, leaving open the possibility of deferring those decisions to a later fiscal event — whether the Spring Statement or a Spending Review next year — by which point the economic picture may have shifted considerably.

The IFS cautioned that departmental budgets under the spending plans passed down from Rachel Reeves would, within a few years, fall behind the rate of inflation. Leaving the matter unresolved, the IFS warned, would place the government's plans under a cloud of doubt about their reliability. Spending forecasts set by some Treasury holders have on occasion been constructed in ways that made fiscal targets appear attainable at the moment of announcement, only for those numbers to be adjusted downward once the scrutiny of the announcement period had faded.