According to the National Institute of Economic and Social Research’s (NIESR) latest UK Economic Outlook, the Government is projected to fall short of its fiscal ‘stability rule’ by £41.2 billion in the 2029-30 financial year—forcing the Chancellor to consider major tax hikes in the upcoming Autumn Budget to remain within her fiscal constraints.
The deterioration in the public finances stems from several converging factors, including a sharp rise in government borrowing, the rollback of welfare reductions, and lower-than-anticipated GDP growth. These developments have collectively deepened the UK’s fiscal challenges in recent months.
As a result, the Chancellor now confronts what NIESR describes as an “impossible trilemma”: the struggle to uphold fiscal discipline while delivering on public spending plans and honouring manifesto pledges not to increase taxes.
Against this backdrop we project UK GDP to grow modestly at 1.3 per cent in 2025 and 1.2 per cent in 2026, placing the UK in the middle of the G7 economies.
We expect CPI inflation to remain significantly above the MPC’s target, at around 3.5 per cent in 2025, and 3 per cent in the second quarter of 2026. This is mainly due to persistently high wage inflation, and the inflationary effects of the fiscal expansion announced in the Autumn 2024 Budget.
As for monetary policy, despite the persistence of inflation, we expect the Bank of England to cut interest rates twice this year, with a further cut expected at the beginning of 2026. This would bring the policy rate down to 3.5 per cent, our view of the natural nominal interest rate (r*).
The cost-of-living crisis is still ongoing, affecting the poorest in our society the most. The living standards of the poorest 10 per cent of UK households are falling. In 2024-25 they declined by 1.3 per cent compared with 2023-24 and are some 10 per cent lower than pre-Covid levels.
Given this outlook, we would recommend that the Government:
- Builds a large fiscal buffer via a moderate but sustained increase in taxes. This will help allay bond market fears about fiscal sustainability, which may in turn reduce borrowing costs. It will also help to reduce policy uncertainty, which can hit both business and consumer confidence.
- Reduces welfare spending by bringing down the level of economic inactivity, for example through a faster disbursement of the £1 billion earmarked for pathways (back) to work.
- Reforms the Council Tax Bands or, even more radically, replaces the whole Council Tax system with a land value tax.
Professor Stephen Millard, Deputy Director for Macroeconomics, said: “With growth at only 1.3 per cent and inflation above target, things are not looking good for the Chancellor who will need to either raise taxes or reduce spending or both in the October Budget if she is to meet her fiscal rules.”
Professor Adrian Pabst, Deputy Director for Public Policy, said: “The government needs a guiding narrative that can anchor an ambitious policy programme. While there have been welcome announcements on public investment in the Comprehensive Spending Review, what’s missing is much closer coordination across government and with lower tiers of government on driving forward pro-growth and pro-productivity policies.
This should be a top priority for government if it wants to meet its mission of kickstarting the fastest growth among the G7 economies and boosting living standards in every part of the United Kingdom.”
