UK warned of real spending squeeze ahead of Autumn Budget

The UK faces a 4% real spending squeeze by the end of the decade totalling around 24 billion in 2023 prices due to higher and more persistent inflation. The impact of this will no doubt create some very difficult trade-offs in the upcoming Autumn Budget, according to NIESR’s latest quarterly Economic Outlook.

The report underscores the severe policy constraints awaiting newly appointed Prime Minister Andy Burnham and Chancellor John Healey ahead of their first Budget.

A challenging inheritance

“Prime Minister Andy Burnham faces a challenging inheritance — eroded real spending plans, the highest borrowing costs in the G7, new spending demands and cost-of-living pressures. Debt is projected to stabilise, but there is no plan yet to bring it down,” said David Aikman, NIESR director.

The clear message on the day from NIESR was that any new commitments on defence and improving living standards must be funded through taxation or savings elsewhere, rather than further borrowing.

“Every major shock this century has ratcheted the debt ratio higher, and none of that increase has been reversed. If we are to rebuild the capacity to absorb the next shock, we will need a determined plan to bring debt down over time,” said Aikman.

“It is not hard to imagine where that next shock may come from: from the still-unsettled situation in the Middle East, or from a sharp correction in US equity markets, where valuations rest heavily not just on AI delivering, but on today’s leading firms capturing a large slice of the eventual returns.”

UK growth and inflation

With regard to growth, despite ongoing geopolitical volatility in the Middle East and renewed disruptions in the Strait of Hormuz, the UK economy was found to be more resilient than expected in the first half of the year, prompting a slight upward revision in full-year GDP growth to 1.1% in 2026 (up from 0.9 per cent in NIESR’s spring projection) and 1.1% again in 2027.

However, the NIESR warned that the second half of 2026 will see a marked deceleration as high energy costs compress household incomes and lingering geopolitical uncertainty weighs heavily on private business investment.

“The UK economy proved to be surprisingly resilient in the first half of this year, but a slowdown is still to come. Even if peace is restored relatively quickly in the Middle East, inflation will still rise and the new Chancellor will need to make some difficult decisions with respect to how to fund the latest policy announcements, from cuts to VAT on electricity and business rates for pubs, to the £2 bus fare cap,” said Stephen Millard, deputy director for macroeconomics.

The think tank also announced that inflation will be heading back up, estimated to peak at about 3.8% early next year, with a return to the 2% target not expected until early 2029.

Labour market conditions

Unemployment was forecast to rise modestly to a peak of 5.3% in late 2026 before easing back to its natural rate of 5% by late 2028.

Living standards also remain under pressure with NIESR currently projecting real personal disposable income to grow by 1% in 2026 but only by 0.1 per cent in 2027 as the higher inflation caused by the rise in energy prices kicks in.

Unfortunately the ongoing crisis of young people not in education, employment or training (NEET) was marked to continue with NIESR projecting over one million young Britons (16–24) to remain NEET through 2030. In order to tackle this, it was suggested that targeted local interventions in mental health and vocational education will need to be paired with economic recovery in order to finally shift the dial.

The NIESR Economic Outlook in brief

• The Middle East remains a large source of uncertainty, but NIESR central forecast assumes a relatively swift normalisation
• Global economy affected by two opposing forces, both the war in Iran pushing down on growth versus investment in AI pushing up growth
• UK economy has shown great resilience with GDP growth expected to be 1.1% in both 2026 and 2027
• UK has a high level of public debt and no clear path to bring it down
  Inflation is expected to average 3.1% in 2026 peaking at 3.8% in February next year taking longer to return to target
• The Bank of England’s Monetary Policy Committee is expected to hold interest rates at 3.75% through 2026 and 2027 as labour market slackening mitigates second-round wage price effects
• A challenging inheritance will require some tough calls from the new chancellor in the Autumn Budget