Britain's fiscal watchdog, the Office for Budget Responsibility, said on Tuesday it will take the stronger-than-expected persistence of inflation after the 2022 energy shock into account when it updates its economic and fiscal forecasts later this year.
The announcement signals the OBR may cut its estimate of the government's fiscal buffer by more than some forecasters have anticipated. The watchdog's projections determine the scope for public spending and are closely watched by markets and politicians because they set out official assumptions for growth, inflation and borrowing.
The OBR's most recent forecast package, published on March 3, indicated finance minister Rachel Reeves had roughly A324 billion of headroom to meet her objective of a balanced budget, excluding investment spending, by 2029-30. Those numbers did not reflect the effects of the Iran war, which began on February 28 and has led the Bank of England to expect higher inflation and weaker growth.
In an annual review of its forecasting record, the OBR said it would draw lessons from the 2022 energy shock that followed Russia's full-scale invasion of Ukraine when preparing fresh forecasts for the finance minister's annual budget later this year.
"We have adjusted our analytical and modelling toolkit, including our assumption for the second-round pass-through of energy prices to inflation and some of our short-term inflation modelling," it said.
The OBR noted the last energy shock produced higher inflation, increased public spending and greater government borrowing and debt than the office had forecast both at the time and in subsequent years. That experience has prompted changes to analytical methods as the watchdog readies its next formal assessment.
Finance minister Rachel Reeves has said she does not intend to reintroduce broad, costly universal energy subsidies of the kind used by the previous Conservative government in 2022. The OBR's updated modelling will therefore evaluate the fiscal outlook without assuming a return to that policy stance.
The Bank of England has signalled there are some reasons to expect inflation will be less persistent than it was after the 2022 shock, citing greater slack in the economy and a smaller rise in natural gas prices. The OBR's decision to alter its treatment of energy pass-through and short-term inflation modelling comes against that mixed backdrop.
For reference, the article noted the exchange rate at the time of reporting: $1 = 0.7426 pounds.